August 2005)

ALL CHANGE: TURKEY ASEAN NATIONS FIRMS WAKE UP TO RECONSIDERS ITS BALANCE COMPETITION BENEFITS OF TAILOROPTIONS AND COOPERATION PAGE 28 MADE SOFTWARE PAGE 48 PAGE 22 SURVEY: THE WORLD’S BEST SUB-CUSTODIANS

JULY/AUGUST 2005

The turmoil at the heart of the EU raises questions for companies doing business in Europe

EUROPE ON THE BRINK PAGE 12

DEAR READER

JULY/AUGUST 2005 | VOL.19 NO.7

Continental Drift ALL CHANGE: TURKEY ASEAN NATIONS FIRMS WAKE UP TO RECONSIDERS ITS BALANCE COMPETITION BENEFITS OF TAILOROPTIONS AND COOPERATION PAGE 28 MADE SOFTWARE PAGE 48 PAGE 22 SURVEY: THE WORLD’S BEST SUB-CUSTODIANS

JULY/AUGUST 2005

The turmoil at the heart of the EU raises questions for companies doing business in Europe

EUROPE ON THE BRINK PAGE 12

s continental Europeans head to the coasts for their long summer holidays, they will travel through a Europe in turmoil, a Europe that is struggling to remain competitive in a global market, a community that is questioning the very principles on which it was founded. Many of the difficulties the continent is facing have existed for some time, but the euro’s dramatic recent slide against the dollar has rattled both investors and corporations and has brought into sharper focus other, more structural problems with which the European Union is wrestling. There is no doubt Europe is facing some immense challenges. Italy is already in a technical recession, Germany and France are both foundering, and the proposed EU constitution lies in ruins, despite Luxembourg’s belated attempt to resuscitate it.The persistent malaise is encouraging the continent’s perennial malcontents, who are becoming increasingly vocal in their condemnation of last year’s enlargement that saw 10 nations join the union in a flurry of optimism and comradely bonhomie. The gloomiest pundits are predicting a rapid meltdown, with the single currency disintegrating as one nation after another frees itself from the straitjacket of the euro and reclaims its old currency—and the freedom to manage its own monetary policy. But, as we find out in this month’s cover story, Europe’s single currency is far from down for the count. In fact, as the dollar rose sharply in early July, it appears some Asian central banks took the opportunity to snap up some cheap euros, continuing their shrewd policy of balancing their enormous dollar reserves with a growing stash of euros.With many analysts predicting that the euro will recover the ground it recently lost to the greenback, this is a smart move. Not only is the single currency likely to claw its way back against the dollar; Europe’s economy is poised for continued growth. Labor reform is progressing, albeit slowly, in Germany and France (see page 17), which will help them improve their competitiveness in the long term. And, far from dragging down the region as a whole, last year’s new entrants will bring a dynamism and energy to the EU that will fuel further growth in the years to come.With continued commitment and determination, the state of the union can only get better. Until next month.

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Dan Keeler [email protected]

EDITOR IN CHIEF AND CHAIRMAN: PAOLO PANERAI PUBLISHER AND PRESIDENT: JOSEPH D. GIARRAPUTO

EDITOR: DAN KEELER EUROPE EDITOR/LONDON: ANITA HAWSER CONTRIBUTING WRITERS: GORDON W. PLATT, JR., PAULA L. GREEN, MARK LEHANE, LAURENCE NEVILLE, DENISE BEDELL, KEITH LOVEARD, JOACHIM BAMRUD, AARON CHAZE, THOMAS CLOUSE, ANTONIO GUERRERO, KIM ISKYAN PRODUCTION MANAGEMENT (MILAN): GIULIANO CASTAGNETO ART DIRECTION: ER CREATIVITY/ENRICO REDAELLI, CLARA CIOCCHINI COPY EDITOR: TINA ARIDAS

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CONTENTS

COVER STORY 12 Europe on the Edge

JULY/AUGUST 2005 | VOL.19 NO.7

COVER STORY BY MARK LEHANE

The euro’s troubles have brought the problems of the European Union into focus.

REGULARS 1

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FEATURES 17 Regional Report: European Labor Reforms

REGIONAL REPORT: EUROPE BY ANITA HAWSER

REGIONAL REPORT: EUROPEAN DEBT BY LAURENCE NEVILLE

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Turkey’s EU aspirations are faltering as the EU reconsiders its future.

28 Regional Focus: ASEAN SE Asia’s regional trade alliance targets intra-regional cooperation.

COUNTRY REPORT: TURKEY BY PAULA L. GREEN

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Emerging Markets Roundup The latest news from China, India, Russia and Brazil.

REGIONAL FOCUS: ASEAN BY ANITA HAWSER

32 Market Focus: Brazilian ADRs Strong liquidity in the US is helping the ADRs of Brazilian companies perform well.

Milestones Citigroup swaps its asset management business for the broker-dealer operations of Legg Mason; rising oil prices hit Asian currencies hard; debt relief is the subject of “Four Weddings” screenwriter’s latest venture ; and the UK leads growth in M&A activity.

European companies are trapped in the fallout from downgrades of General Motors and Ford.

22 Country Report: Turkey

Newsmakers New Securities and Exchange Commission head expected to take softer stance; Enrique V. Iglesias cuts short his tenure at the IADB; US treasury secretary Snow contends with Chinese bid for California oil company Unocal; and the Middle East announces plans for its first energy futures exchange in Dubai.

Countries that have failed to reform their labor markets will soon have to bite the bullet.

20 Regional Report: European Debt Markets

Dear Reader A letter from the editor.

10 EM Investor Key information for investors in emerging markets.

60 Foreign Exchange The European Monetary Union is not about to fall apart, despite the “no” votes in France and the Netherlands on the EU constitution, analysts say.

COUNTRY REPORT: MALAYSIA BY KEITH LOVEARD

40 Country Report: Malaysia 65 Corporate Debt

Malaysia is ready for the next stage in its development.

48 Made-to-measure Finance Solutions

66 Global Equity/DRs

A custom-built finance solution is a real alternative to buying out of the box.

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AWARDS WORLD’S BEST SUB-CUSTODIANS

The World’s Best Sub-custodians Global Finance selects the winners in an area of finance that is critical to global investing.

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US companies may repatriate billions of dollars of foreign earnings to pay down their outstanding debt under a new law.

FINANCIAL SOFTWARE BY DENISE BEDELL

IPOs by China’s largest coal producer and its fifth-largest bank are the first of a slew of public offerings by Chinese companies scheduled for later this year.

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Mergers & Acquisitions Bank Austria Creditanstalt will become the leading bank in Central and Eastern Europe after Italy-based UniCredito buys HVB, Germany’s second-largest bank.

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PROPOSED SEC HEAD EXPECTED TO TAKE A GENTLER APPROACH udging by his past actions, Christopher Cox, the pro-business California Republican nominated by President Bush to head the Securities and Exchange Commission, is likely to steer the agency away from the activist path followed by former chairman William H. Donaldson, who resigned on June 30. If confirmed by the Senate, Cox is likely to ease up on the crackdown on corporate fraud led by his predecessor in the wake of the Enron and other financial scandals.The agency already has tempered its stance in recent months in reaction to a corporate backlash over the costs of complying with the Sarbanes-Oxley Act. Cox, a former securities attorney who wrote legislation curbing shareholder lawsuits in 1995,

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has received more than $254,000 in financial support from securities firms during his 16 years in Congress. He also opposed a move to treat stock options as an expense, pleasing his technology-firm constituents in California’s wealthy Orange County, or OC, as it is known in the Fox network TV show. Cox, a graduate of Harvard Law School and Harvard Business School, was a senior associate White House counsel in the Reagan administration.While he has pledged to follow clear and consistently enforced rules at the SEC, he is widely expected to take a more business-friendly approach. He could back away from regulation of hedge funds, for example. Wall Street observers are curious to know whether he will keep Linda Chatman Thomsen on as director of enforcement. She was appointed on May 12 and was expected to be an aggressive enforcer. Observers also will be watching to see if Cox will reconsider the new “trade through” rule requiring brokers to accept the best price for a trade even if stock markets must fill the order through a competitor. —Gordon Platt

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LATIN AMERICA

IGLESIAS' EARLY DEPARTURE PROMPTS RACE FOR SUCCESSOR Enrique V. Iglesias, president of the Inter-American Development Bank (IADB), has decided to cut short his current five-year term in order to hand over control to "new hands." Iglesias, 74, has been at the multilateral bank's helm for 17 years and leaves his successor with some rather large shoes to fill. Iglesias: Iglesias: Stepping Stepping down down Elected to the bank's presidency in 1988, as Latin America was emerging from its "lost decade" of runaway debt and inflation, Iglesias was re-elected in 1993, 1998 and 2003. His latest term was slated to run through 2008. Under his watch the IADB's capital was raised from $26.5 billion to $101 billion, while the investment grade-rated bank became a frequent issuer on international debt markets. "It would be difficult to overstate the contribution that Enrique has made to the Inter-American Development Bank and to economic development in Latin American and Caribbean nations over the last 18 years," said US treasury secretary John Snow in response to Iglesias' decision to step down on September 30. Before joining the IADB—the world's oldest and largest regional development bank—Iglesias was president of Uruguay's central bank and the country's foreign minister. He was also executive secretary of the United Nations Commission for Latin America and the Caribbean (ECLAC) and chairman of the conference that spawned the Uruguay Round of international trade negotiations. He will now become the first secretary general of the Ibero-American Summit. Iglesias is only the third IADB president since it was founded in 1959. So far, there is talk that, because the US is the bank's largest shareholder, with 30% of the voting power, and hosts the IADB headquarters in Washington, the next president could be a Washington insider. By late June only Brazilian central bank governor João Sayad and his Nicaraguan counterpart, Luis Alberto Moreno, were official candidates, though others were expected to emerge. Member nations have until July 16 to submit nominations, with elections set for July 27. —Antonio Guerrero

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UNITED STATES

SNOW FINDS HIMSELF IN ANOTHER TIGHT SPOT REGARDING CHINA When it comes to being in the China “hot seat,” US treasury secretary John Snow is an old hand. He has been pressuring China for the past few years to revalue its currency, while trying to head off protectionist actions against Chinese goods by the US Congress. Now he has another red-hot issue to contend with: the $18.5 billion bid by Chinese oil company CNOOC to acquire Californiabased Unocal, the ninth-largest US oil company, which has a majority of its oil and gas reserves in Asia. The cash bid, largely backed by loans from CNOOC’s state-owned parent, represents a premium of about 10% to US oil company Chevron’s $16.4 billion cash-andstock offer. Snow is chairman of the ComSnow: Watching CNOOC mittee on Foreign Investments in

the United States, or CFIUS, which is being urged by many lawmakers to scrutinize the CNOOC bid to make sure that it doesn’t threaten national security. Congressional critics argue that energy is a strategic resource and that Unocal’s seismic technology could be easily converted to military purposes. Meanwhile, CFIUS also is charged with maintaining the credibility of the US open-investment policy and preserving the confidence of foreign investors in the US.The committee also seeks to assure that US investors abroad are not subject to retaliatory discrimination. Earlier this year, CFIUS approved the purchase by China’s Lenovo Group of IBM’s personal-computer business, despite Congressional concerns that China one day could corner the PC market.As Global Finance went to press, Snow said it was too early to start a review of CNOOC’s bid for Unocal, but the White House promised an appropriate national and economic security review if the Chinese firm is the winning bidder. For its part, China says the offer should be considered as a normal business deal without political interference. —GP

MIDDLE EAST/UNITED STATES

MIDDLE EAST LOOKS TO ENERGY FUTURES The Middle East has taken formative steps toward the establishment of the region’s first energy futures exchange with the announcement of a joint venture between Dubai Holding and the New York Mercantile Exchange (NYMEX) estimated to be worth $10 million. Commenting on NYMEX’s first overseas joint venture, Mitchell Steinhause, NYMEX chairman, said that the new Dubai Mercantile Exchange (DME) would help bridge the time-zone gap between trading in Europe and Asia by creating energy futures products that addressed the growing needs of the regional market. “The contracts traded on DME will be tailored to the needs of the marketplace and may include physical delivery alternatives that represent the physical trade flows,” commented James Newsome, president of NYMEX. Dubai Holding will reportedly make the bulk of the cash investment required to establish the DME, while NYMEX’s expertise in compliance, marketing, research and IT will underpin the development of the new exchange’s trading platform. Trades executed on the DME, which is expected to open for business early next year, will also be cleared through NYMEX’s clearinghouse in New York. The DME’s platform is intended to provide price transparency for sour crude and fuel oil trades. Mohammed Al Gergawi, CEO of Dubai

Holding, said its priority now was to build on the agreement with NYMEX by developing “a platform for managing risk which reflects the increased financial sophistication of the region’s capital markets.” He said DME would build on Dubai’s reputation as a major financial and trading hub. In a separate development, the Dubai International Financial Exchange, which aims to become the main exchange between Western Europe and East Asia targeting issuers in NYMEX’s Steinhause the UAE, Gulf Cooperation Council states and the Middle East, as well as Africa, Turkey and Central Asia, is scheduled to commence operations on September 26. Gergawi said that Dubai had played an integral role in trading commodities and that the DME “would serve the greater need of the Middle East energy markets.” —Anita Hawser

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ASIA

UNITED STATES

ASIAN CURRENCIES TUMBLE AS RISING OIL PRICES HIT THE REGION HARD

CITIGROUP-LEGG MASON DEAL SENDS MESSAGE TO WALL STREET

relatively buoyant US all it the non-petro economy. US consumer currency. The Japanese yen fell to an 8.5-month confidence hit a three-year high in June, suggesting that low against the dollar in late spending will remain strong. June, as oil prices rose above With a revaluation of the $60 a barrel. Other Asian currencies, such as the South Chinese currency expected later this year, the slump in Korean won and the Taiwan Asian currencies may not last dollar, also suffered declines on worries about the region’s for long, however. Hiroshi Watanabe, Japanese vice vulnerability to ever-morefinance minister in charge of expensive overseas oil. international relations, said in While the fall in the yen late June that the yen could and the other Asian rise on speculation following currencies is good news for a change in China’s exchange the region’s exporters, since rate. Watanabe said the they will gain a competitive revaluation of the yuan edge, the jump in oil prices should not be too small, raised concern about a potential slowdown in global since that could lead to speculation on the need for a demand. follow-up move even higher Record prices for crude in the exchange rate. oil could also dampen the —Gordon Platt fragile Japanese economy, since the country imports almost all of its oil. The Tokyo Stock Exchange clung to a gain of only 0.5% in the year-to-date as of late June. The Japanese economy continues to struggle following last year’s recession, and the country’s trade surplus shows signs of weakening. Analysts say the fall in the Asian currencies has been amplified by the general rising trend of the dollar. The greenback has been supported by higher Japan’s Hiroshi Watanabe US interest rates and a

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The time was, not so m a ny ye a rs a g o, when the stock marke t wa s s o a r i n g , that every investm e n t ba n k h a d to own a money manager in order to be a true financial supermarket. Apparently, times a re c h a n g i n g . O n June 24 Citigroup agreed to a $3.7 billion deal under which it will swap the bulk of its assetmanagement business for the broker-dealer oper- Citigroup’s Charles Prince ations of Baltimore, Maryland-based Legg Mason. Citigroup also will receive $1.5 billion of Legg Mason stock, while the Baltimore firm will borrow $550 million for five years from Citigroup’s corporate and investment bank. Citigroup kept its asset-management business in Mexico and its retirement-services business in Latin America, as well as its interest in CitiStreet, a global benefits provider that is a joint venture with State Street. The asset swap will put Citigroup in a neck-and-neck race with Merrill Lynch as the leading US broker. Citigroup will also post an after-tax gain of about $1.6 billion when the deal closes. The New York-based bank will continue offering asset-management products under a three-year global agreement with Legg Mason. Legg Mason—which in a separate transaction also acquired Permal Group, one of the largest funds-of-hedgefunds managers—will emerge as a leading global money manager, with $830 billion in assets under management. In a candid comment to analysts, Citigroup CEO Charles Prince said, “Our performance in asset management is not what we had hoped for it to be.” He suggested that the resources would be better directed elsewhere. What’s more important, the swap enabled both firms to extricate themselves from the conflicts of interest that are unavoidable when the same company offers investment advice and sells its own funds. Other Wall Street firms are expected to get the message. “I think this will be widely perceived on the Street over time,” Prince said. —GP

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UNITED KINGDOM

FOUR WEDDINGS SCREENWRITER LENDS A ROMANTIC INTERPRETATION TO DEBT RELIEF First it was Bono, singer of the rock band U2, and other musicians and activists who pushed political and economic leaders of the industrial nations to forgive the debt of the world’s poorest nations. Now it’s Hollywood’s turn. HBO Films and BBC Productions have co-produced a film, “The Girl in the Café,” that has the Herculean task of turning world poverty and the political choices global leaders face at the July G-8 Summit in Scotland into an artistic endeavor that people will watch. Bono with Tony Blair The romantic comedy by screenwriter Richard Curtis, who also wrote the successful films “Four Weddings and a Funeral,”“Notting Hill” and “Bridget Jones’ Diary,” builds on the momentum of debt cancellation that has been gaining in circles from London to New York to Hollywood over the past several years. British Prime Minister Tony Blair, the current chairman of the G-8 group, has aggressively pushed for debt cancellation to be

placed high on the summit agenda, and in early June the G-8 finance ministers finally hammered out an accord to write off $40 billion in debt for the world’s poorest nations. Late in June the United Nations held a two-day meeting of finance and development ministers and financial institutions to find ways to push the debt relief program forward and finance the work of the Millennium Development Goals, or MDGs. The MDGs are a central theme of Curtis’s film, which traces the journey of a lonely English bureaucrat working for the British finance ministry and a mysterious woman he meets in a café on Downing Street.They go to a G-8 conference in Reykjavik, Iceland, and the romance plays out as the British negotiating team pushes an agenda to meet the MDGs and greatly decrease poverty by 2015. It might not make for great cinema, but if life really does imitate art, the stage will be set for a breakthrough in debt relief. —Paula L. Green

GLOBAL

WESTERN EUROPE STREAKS PAST US IN M&A ACTIVITY To the casual observer it might look as though M&A activity globally during the first half of 2005 was less than inspiring. Activity did increase when compared with the same period last year, but growth was modest. A closer look, however, reveals hotspots such as the UK market, which grew 40%, and important developments such as Western Europe overtaking the US by deal value and volume. Consultancy KPMG’s corporate finance division estimates that globally at the end of the first half $771 billion of deals and 12,400 deal closures will have been completed — a 14% increase on both the value and the volume of deals closed in the first half of 2004, based on figures from investment banking information provider Dealogic. “There is a feeling that hope is coming back to the market,” says Simon Collins, CEO of KPMG’s UK corporate finance team. “In the UK and Western Europe there is a good story unfolding, and, of course, activity in Asia-Pacific is rampant. On the downside, activity in the US market appears to be dwindling.” Collins notes that one global trend is the increase in the number of large deals. “The market is now largely driven by a handful of mega-deals,” he says. The continued strength of the debt and equity capital markets—despite the spate of volatility resulting from the downgrade

of Ford and GM in March—has played a major role in the growth of M&A activity. “The volatility that we have seen in recent months has only affected fringe players,” explains Collins. “Private equity houses still have access to huge sums for investment, and for corporates the bank lending market is as attractive as it has ever been. Banks are extremely liquid and have to invest that money somewhere.” At first glance some of the areas of greatest growth seem counterintuitive: UK real estate is a sector many consider overvalued while Western Simon Collins Europe and Japan are widely perceived to be economically stagnant. But, as Collins explains, M&A is not necessarily driven by boom times. “The role of M&A in restructuring is just as important as it is during buoyant economic conditions,” he says. “CEOs don’t necessarily need strong economic conditions or even strong financial markets to do deals, although it helps. What they really need is confidence, and what we are seeing now are cautious forays into M&A and growing confidence.” —Laurence Neville

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STATE GOVERNMENTS CHASE INVESTMENT

MONETARY TIGHTENING PAYS OFF

ndia’s state governments have begun to push hard for foreign investments. Among them is the reclusive state of Kerala, which has suffered from the fact that investors have been wary of its elected communist state government. Now, however, it is aggressively pursuing foreign investments: An investment from BMW to set up an automobile assembly plant is high on its agenda. Taking a different approach is the state of Maharashtra, which is already one of the most industrialized in India. It is pinning its development hopes on becoming a biotechnology and software hub for Asia and globally.A delegation of senior bureaucrats led by the chief minister, Vilasrao Deshmukh, toured major companies in the US recently to press for more investments in these sectors. Maharastra’s move is all the

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more timely, given that Enron’s controversial and partly completed gas-fired 2400-megawatt power project in Dabhol, Maharashtra state, has been lying defunct since that company collapsed. Now, GE Energy and Bechtel, which own 85% of the Dabhol Power Company, are hoping to work with Bharat Heavy Electricals and power generator National Thermal Power Corporation to restart the $2.9 billion project.The Gas Authority of India, Maharashtra State Electricity Board and Indian financial institutions are creating a special-purpose vehicle to run the plant after completion. And while India’s economy has been on a tear recently, meteorologists are predicting a delay in the arrival of the monsoon—something that typically causes a drop in India’s GDP growth. Despite the delay, though, the stock markets reflect growing optimism. In late June the Bombay Sensitive Index passed the 7,000 mark for the first time ever, on the back of strong liquidity flows. Indian corporate results in the past few quarters have been spectacular and are keeping up investor interest. —Aaron Chaze

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The Brazilian central bank’s nearly year-long monetary policy tightening drive is finally bearing fruit. The monetary policy committee (Copom) hiked the benchmark Selic interest rate by 375 basis points since last September in a move to curb inflation. Monthly inflation duly fellGERMANY, and in May SWITZERLAND, was down to 0.49%—well below initial expectations of as much as 0.58%. Antonio Palocci Easing inflation led Copom to keep interest rates unchanged in June, though at a 20month high of 19.75%. The government, which maintains its 5.1% inflation target for 2005 and 4.5% for 2006, announced in June that the target would remain steady at 4.5% for 2007. Economists feel inflation will end this year closer to 6%, which is still within the central bank’s tolerance margin of up to 6.5%. Concerns remain that continuing high interest rates will dampen economic growth, as economists revised 2005 GDP forecasts to 2.8% from 3.7%. With the average rate on consumer loans rising to a 17-month high of 65.7% in May (33.7% average rate on corporate loans), bank lending grew by only 0.5% in May, which represents a 16-month low. Authorities counter that suspending rate increases will help fuel growth by year-end. A mounting political scandal could, however, revive the inflation bogey. Cabinet chief José Dirceu, a close ally of President Luiz Inácio Lula da Silva, resigned in June amid charges that he was aware of alleged ruling Workers’ Party bribes to legislators in exchange for congressional support. The scandal also includes allegations of corruption at state-owned companies, leading to a series of high-level inquiries. Lula supports the investigations and has promised a package of anti-corruption reforms, and authorities contend the situation will not affect economic growth prospects. “Political problems are resolved in the political arena, and economic problems are resolved in the economic arena,” says finance minister Antonio Palocci. Economists, however, are monitoring the scandal for signs of a potential crisis. —Antonio Guerrero

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CHINESE FIRMS EMBARK ON SHOPPING SPREE hinese companies continued to demonstrate their economic prowess and enthusiasm for expansion abroad with several headline-grabbing bids in June. US-based oil and gas producer Unocal announced on June 22 that it had received an offer of $18.5 billion to be acquired by state-owned Chinese National Offshore Oil Company (CNOOC). If successful, the deal will rank as the largest overseas acquisition by any Chinese firm. CNOOC’s bid comes less than two weeks after the Federal Trade Commission (FTC) approved an earlier agreement for US-based Chevron to purchase Unocal. CNOOC will take on significant debt and face possible US regulatory hurdles if Unocal accepts its offer. In another highly publicized move, Chinese appliance-maker Haier led a group of investors in a $1.28 billion offer for US-based Maytag Corporation. Haier’s offer, like that of CNOOC, challenges an earlier purchase agreement with an American firm. If it successfully passes due diligence and approval procedures, the acquisition will strengthen the Chinese company’s brand name and international distribution networks. While Chinese companies look for investments abroad, foreign banks continue to break ground in China. Bank of America announced on June 16 that it would pay $3 billion for a 9% stake in state-owned China Construction Bank in the single largest foreign investment in China’s banking sector. Bank of America can also increase its ownership to 19.9% over the next five and a half years. According to its website, Switzerland-based UBS is also considering a $500 million investment in Bank of China, another of China’s state-owned banks.

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China has announced that it will introduce a new textile quota system as part of a deal brokered with the European Union in midJune. The new Oil giant CNOOC joined the rush to snap up foreign assets system, which takes effect on July 20, will set limits based on each company’s exports during the previous 12 months. China eliminated its textile quotas at the beginning of the year, but surging trade deficits have fueled support for trade restrictions in the US and the EU. The new quotas will diffuse tension with the EU and may facilitate further negotiation with the US, which imposed its own trade restrictions in May. China’s disease control system is again the focus of controversy, more than two years after the international community criticized SWITZERLAND, GERMANY, STATES the country’s handling of the UNITED SARS crisis. Recent media reports have alleged that the Chinese government encouraged farmers to give the anti-viral drug amantadine, which is used to treat the flu in human beings, to poultry. The use of amantadine on animals violates international guidelines and may have led to the resistant forms of the bird flu virus that have killed people in Cambodia, Thailand and Vietnam. The Chinese government has denied the accusations and promised to investigate. —Thomas Clouse

RUSSIA

OLIGARCHS TREMBLE AFTER KHODORKOVSKY’S CONVICTION he trial of former Yukos Oil Company head Mikhail Khodorkovsky finally ended, as the former oligarch was sentenced to nine years in a prison camp on charges of fraud and tax evasion. A few days later, a top government prosecutor warned darkly that the government planned to bring charges against other oligarchs, sending a brief shiver through markets. The late May blackout that left millions in Moscow and

T Chubais: Takes the blame

surrounding regions without power resulted in calls for the resignation of Unified Energy Systems head Anatoly Chubais.The target of an assassination attempt earlier in the year, and one of Russia’s least popular figures due in part to his role in the privatizations of the 1990s, Chubais took blame for the blackout but said he would not quit. The flow of public offerings by Russian corporates continued. In early June Russia’s biggest

steelmaker, Evraz, sold an 8.3% stake to raise $422 million in an IPO on the London Stock Exchange. Shares were sold toward the lower end of the targeted range, with the backdrop of steel prices falling to a 15month low. A week later Rambler Media, a television broadcaster that controls Russia’s second-largest Internet search engine, went public on London’s Alternative Investment Market, raising $40 million. —Kim Iskyan

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FUND FOCUSES ON INDIA’S YUPPIES

TAIWANESE TECHNOLOGY COMPANIES JUMP BACK IN MARKET

umbai-based Birla Mutual Fund is launching the Birla India GenNext Fund, which will invest in equities of companies that are expected to gain from the free-spending habits of India’s young urban professionals, or Yuppies. The company says more young people in India are buying houses and cars, using cell phones and taking vacations. “This is a fund driven by the lives and aspirations S.V. Prasad of India’s

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youth,” says S.V. Prasad, chief executive of Birla Mutual Fund.“The fund intends to take advantage of the large opportunity created by the emergence of GenNext—the young generation—as the largest population cohort in the country and its lavish spending habits,” Prasad says. The initial offering of the fund, which will invest in companies that cater directly to consumers, closes on July 12, 2005. Birla Sun Life Asset Management, the investment manager for the fund, is a joint venture of the Aditya Birla Group and Canada-based Sun Life Financials.The Aditya Birla Group is one of the largest conglomerates in India. —Gordon Platt

COMPANY TO WATCH: HYUNDAI MOTOR/SOUTH KOREA

SHIFTING TO OVERDRIVE

outh Korea’s Hyundai Motor is stepping up its globalization campaign. In late June it revealed jointventure plans with China’s Guangzhou Motor Group to produce trucks and buses in China.The two partners will build a plant in the port city of Huadu, Guangdong province. The initial annual production capacity of 20,000 units in

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2007 will be expanded to 200,000 by 2011, with a total investment of $1.24 billion. “This commercial vehicle joint venture is critical to reach our goal of producing 1 million cars in China by 2008,” says Hyundai’s chairman and CEO, Chung Mong-Koo. China’s bus market is seven times larger than South Korea’s, but its light and

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Taiwan-based technology companies, which accounted for the vast majority of capital raised via global depositary receipts in 2003, are returning to the market. In one of the biggest issues of the year to date, Chi Mei Optoelectronics, or CMO, which makes flat screens for computers and televisions, raised $751 million in June through a follow-on offering of GDRs. CMO jumped into the market ahead of a wave of new offerings by technology companies in Taiwan, which need capital to expand, in part to serve the fast-growing Chinese market. A global leader in the production of flat TV screens, CMO told investors on itsGERMANY, road show UNITED for the offering SWITZERLAND, STATESthat the market for these displays is ready to rise sharply now that retail prices have fallen. The company expects flat-screen TVs to begin retailing for less than $1,000 by the end of this year. CMO will use part of the proceeds of its GDR offering to double the capacity of its existing plant and to build a $1.1 billion facility to make screens up to 47 inches that is scheduled to begin production in 2007. Like many Taiwanese issuers, CMO made use of Rule 144A instruments available only to institutional accounts. These issues are relatively quick and inexpensive, since they don’t have to be registered under the Securities Act. CMO was only the sixth Taiwanese company to access the equity markets this year, but a number of flat-screen manufacturers are ready to follow. Quanta Display plans either a rights issue or a GDR issue. AU Optronics plans to launch an ADR this year. —GP

medium-duty truck market is 100 times larger than South Korea’s. Hyundai already has a joint venture with Beijing Industry Automotive Holdings, which was established in 2002. These are busy times for Hyundai, which in May opened its first US car plant— a $1.1 billion complex near Montgomery, Alabama, capable of producing 300,000 vehicles annually. In addition, Hyundai is building a second assembly plant in India, adjacent to its

existing facility in the southeastern port city of Chennai.When completed by 2007, Hyundai’s manufacturing capacity at Chennai will reach 400,000 units. It not only will serve the fast-growing Indian car market but will export to Europe, Latin America and the Middle East. Hyundai employs more than 68,000 people worldwide and posted $26.1 billion in sales in 2004. Its vehicles are sold in 193 countries. —GP

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Commercial International Bank Adds New Divisions Expansion underlines commitment to meeting needs of clients Successful banks continually strive to improve themselves, and that certainly is the case at the Commercial International Bank (CIB), Egypt’s largest private sector bank and the country’s most profitable financial services institution. CIB, which is also Egypt’s fifth-largest financial institution in terms of asset size, has recently established new divisions to offer new services to its clients. Foremost among these are the Corporate and Trade Finance divisions. A vibrant private sector is a crucial part of any successful economy, and it is important that companies have ready access to capital and to advice when they seek to grow, to make acquisitions or to restructure. That is where CIB's corporate finance division comes in: Capitalizing on its strong placement capabilities, CIB's strong local, regional and international connections allow clients to approach potential equity participants to set up and raise equity stakes in greenfield or expansion projects.

The division offers advisory services on appropriate valuation and negotiation on the terms of sale or purchase, ensuring the client gets the very best available price. The services cover acquisitions, sales of public and private companies, strategic divestitures and restructuring programs. Vigorous trade flows are also crucial to any modern economy, and here, too, CIB is ideally positioned to offer state-of-the-art services to its clients. The Trade Finance division offers a variety of tools, ranging from conventional tools to a multitude of products specially tailored to accommodate specific deal structures. These tools can be used to accommodate both corporate and non-corporate clients. Products include warehouse receipt financing, advances against assignments, collateralized working capital facilities, commodity trade finance, documentary credits, documentary collections and discounting under import/export transactions.

These new divisions complement the bank’s five subsidiaries: Established in 1998, CIBC is Egypt’s premier stock broker. The company has the widest brokerage network in Egypt, with seven branches. A one-stop shop for all brokerage and investment needs, CIBC’s central tenets are reliability, competence and personal service, and it aims to provide customers with seamless investment solutions that are in tune with growing market sophistication. Commercial International Life Insurance Company (CIL) offers a broad range of savings and protection plans. The company’s principal shareholders, CIB and Legal & General, were brought together by the International Finance Corporation and strengthened by the participation of El Mansour & El Maghraby Investment and Development Group. Established in 2001, Contact is the market leader in car financing and related services in Egypt. Owned in conjunction with other leading financial institutions, Contact provides affordable, efficient and manufacturer-independent financing tools and services to passenger-car buyers across Egypt. Corporate Leasing Company (Egypt) “CorpLease” is a new addition to CIB's product portfolio. Owned by CIB and international investors, CorpLease is a broad-based financial services company providing a full range of leasing products and services. The company operates in most asset classes across a wide range of industries, and it is best placed to serve the asset finance needs of the corporate sector. Launched in late 2004, Commercial International Asset Management is the newest addition to CIB’s financial services group. As the first private institutional asset management firm in Egypt, CI Asset Management serves a wide variety of clients through its wide range of products of equity and money markets mutual funds as well as segregated portfolios. Total assets under management reached LE 1.3 billion as of May 2005.

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COVER STORY EUROPE

BY MARK LEHANE

LIVING ON

Just months after analysts began suggesting it could topple the dollar as the world’s favorite currency, the euro has been shaken to the core. Its troubles have brought into focus the problems at the heart of the European Union. or believers in the European project, the news just keeps getting worse. On May 13, French citizens delivered an astounding slap in the face to their political leaders, voting against a new constitution for Europe drawn up by a former French president. Just one week later, an even larger percentage of Dutch voters said no.That immediately plunged the European Union into turmoil. Any hopes of salvaging something from the wreckage were dealt a brutal blow when a late-June summit of EU leaders ended in acrimony. Ostensibly, the argument was over French desire to revise a British budget rebate won by then-UK Prime Minister Margaret Thatcher back in 1984; in reality it reflected cataclysmic fault lines in how the various European countries saw the future of the Union. “The Union is not in crisis,” said JeanClaude Juncker, Prime Minister of Luxembourg and outgoing president of the EU Council of Ministers. “It is in a profound crisis.” But the tortured politics don’t just reflect the clashing of national pride. They also reflect wrenching economic stresses. Many of Europe’s economies are on the rack. Germany is forecast to grow by just 0.7% this year. Italy is in recession. And one in 10 French people are out of work.

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Many ordinary voters blame the euro, as, increasingly, do their leaders. Intent on establishing its inflation-taming credentials, the seven-year-old European Central Bank has stubbornly refused to cut interest rates, which have stood around the 2% mark for the past two years. That’s played havoc with some economies.“You just need to look at the evidence before your eyes to see that it has been a disaster for the German economy,” says Niall Ferguson, professor of history at Harvard and a senior fellow at

able: Might the euro collapse before it makes its 10th birthday?

Pondering the Imponderable The demise of the euro is not as improbable as it first sounds. Investment banks in London have already begun to circulate notes on possible exit strategies from the currency.The French and Dutch “no” votes to the constitution were at least partly a reaction against the euro, and those swelling tides of discontent have encouraged those politicians who want

“A EURO HOVERING NEAR $1.40 WOULD CHOKE THE EUROZONE FURTHER AND BE DAMAGING TO EUROZONE GROWTH” “At those sorts of exchange rates they’re not going to have much in the way of trade either.” —Robin Bew, Economist Intelligence Unit the Hoover Institution at Stanford. Germany’s citizens seem to agree. A recent poll in the weekly German magazine Stern showed that 56% of respondents wanted the deutsche mark back. That’s led some to start thinking the unthink-

the option of scrapping the single currency put on the table. Immediately after the Dutch “no” vote, Italian welfare minister Roberto Maroni suggested that Italy should re-adopt the lira. While those calls still largely come

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THE EDGE

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from the political margins, there are signs that even more level heads are wrestling with the practicalities of a break-up of the euro. In May the German finance ministry was forced to deny that officials had discussed the “What if?” question with their political masters. In truth, the underpinnings of the single currency have begun to look a little worn around the edges, with key countries flouting rules on public finances by running budget deficits above the 3% level agreed under the Maastricht treaty. With Europe’s population rapidly aging, the fiscal climate looks certain to worsen in the absence of reforms to tighten budgets or boost long-term growth. Moritz Kraemer, an analyst at S&P in London,

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says that, on current projections, deficits in France and Germany (and the US) will rise to over 200% of GDP by 2050, levels “more akin to those currently associated with speculative-grade sovereigns.” Unsurprisingly, the euro establishment is fighting back. “Absurd,” is how JeanClaude Trichet, president of the European Central Bank, describes talk of a break-up of the currency.“The euro is an old-style marriage where divorce does not exist,” says Joaquim Almunia, the Spaniard who as EU monetary affairs commissioner is point man for the single currency. Technically, he’s right. There is no provision for a country leaving the euro; in theory they would have to leave the European Union itself.

EUROPE

But what signals are the markets sending out? Mixed ones, say most observers. In late June the euro stood at $1.22, down from a high of $1.35 at the start of the year. Gold hit a high of $438 an ounce equivalent in euros, at least partly on the back of investors seeking a safe haven from the turmoil surrounding Europe. On balance, analysts think the currency will remain weak but won’t fall into a swoon.“I don’t think we are going to see a collapse of the euro,” says Sebastian Paris Horvitz, deputy director for investment strategy at AXA Investment Managers in Paris,“but we could certainly see it going down to $1.20.”

A Storm in a Teacup? ITALY PAINTS ITSELF INTO A CORNER f Europe is in crisis, then it is Italy that is in deepest. The fourth-largest economy in Europe is mired in recession, its public finances are deteriorating, and it has a political class that has even less of a clue about the way out of its problems than the rest of the continent.

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Little wonder that the country is now widely viewed as the weakest link in the European system. “There’s no other way out for Italy,” says Charles Dumas at the respected London-based economic research company Lombard Street Research. “They have to get out of the euro.” That’s a message being flashed out in Italy itself. Roberto Maroni, welfare minister and a leading figure in the Northern League, a regionalist party that is a rebellious member of the ruling coalition, is collecting signatures for a referendum on euro membership. Bringing back the lira strikes a chord with many Italian citizens who blame the single currency for a host of ills, including, they say, higher prices. But few observers expect Italy to walk out of the club lightly. The key reason: the national debt, which stands at nearly 107% of GDP, a level more often associated with Latin America than Europe. Membership in the euro has brought Italian government bond yields to within a sliver of those paid by Germany. A euro exit likely would send spreads rocketing, adding billions of lira to its debt-servicing costs. But how to address the country’s long list of economic woes? Here’s a snapshot of what has been ailing Italy. GDP slowed by half a percentage point in the first quarter of 2005, as it did in the last three months of 2004. The trade balance also went into the red, a tangible reflection of the country’s worsening terms of trade. Since the country entered the euro, its labor costs have risen by some 20% relative to Germany, according to figures from the Organization for Economic Co-operation and Development. Heavily dependent on making shoes, clothes and household appliances, the Italian economy has found it harder and harder to resist competition from China. In the past, Italy devalued its currency to regain competitiveness. That’s not an option with the euro in place. Some members of the government have expressed a determination to get the economy on track. New finance minister Domenico Siniscalco has pledged to clean up public finances, long clouded by one-off, Band Aid gestures. “The times of creative finances are over,” he said in May. But with national elections looming in spring 2006, and the government standing low in the opinion polls, it is hard to see how he can take any tough measures to get finances back on track. Already, a tax cut planned for this year has been shelved. But there’s little appetite for structural reform in the opposition ranks. And looming demographic pressures threaten to overwhelm what little tinkering has already been done with pensions. In Roman times, signs were placed at the spot where three roads diverged—the source of our modern word “trivia.” Many observers say Italy stands at a similar juncture. It can try to bump along as it is now and hope that swelling worldwide growth floats it off its bumpy bottom-ride. Or, so bruised by job losses at home, it might swallow its pride and take a leap into the unknown with a voluntary exit from the single currency. Or investors may become so nervy over its economic prospects that they begin a bond sell-off that forces it out of the euro. None of these three paths will be easy.

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The fate of the euro is not just determined in Europe. Robin Bew, chief economist at the Economist Intelligence Unit in London, argues that concerns over the US current account deficit may cause the dollar to slide again. “Worries over the EU constitution will actually start to fade,” says Bew. “But there is this big structural issue which remains in place—the size of the US current account deficit and the need for them to fund that over the long term. That’s still there, and it’s not getting any smaller. In fact, it is getting quite a bit larger. We’re looking for $1.40 by the beginning of 2006.” The irony is, of course, that a strong single currency has stoked many of the tensions that now threaten to tear it apart.A euro hovering near $1.40 would choke the eurozone still further, says Bew. “At those sorts of rates it is very damaging to eurozone growth. They haven’t really got much in the way of domestic demand; at those sorts of exchange rates they’re not going to have much in the way of trade either.” But what is the bond market signaling? If bond buyers were seriously worried about the euro splitting up, they would logically be marking down bond prices on likely exit countries, pushing yields up.The 10-year interest rate on an Italian

COVER STORY

bond had moved out to 22 basis points over its German counterpart by early June—the largest difference since October 2002 and twice the level seen at the end of May. Credit default swaps— contracts that protect the buyer against a borrower not paying its bonds—had already begun to move in anticipation of “no” votes in the referendums. Spreads on default swaps issued on Portuguese, Italian and Greek bonds had moved out by up to 100% from a month before. Still, at spreads of up to 22 basis points they signaled a sovereign default as extremely unlikely. And even weaker names found it easy to sell bonds after the referendums. Italy effortlessly placed up to €5 billion of bonds during June. Maria Cannata, head of funding at the Italian treasury, says the question of an Italian exit from the euro is not discussed in serious circles. “The stability granted by the euro, the protection against currency speculation and the benefits of low interest rates are universally acknowledged,” she says. There are other practical reasons for doubting that any country will exit the EU, says Graham Bishop, a Londonbased independent consultant involved in the preparatory work for setting up the single currency. He points out that it took three years to put the euro infrastructure in place—such as installing new slot machines for public transport. These could not be changed back overnight.Any switch back to a national currency would also give that country’s citizens a risk-free windfall. Knowing the new currency would trade at a lower value, they would immediately be tempted to withdraw their euros, put them on deposit with a foreign bank and then convert back into the new domestic currency at a better rate. “Without capital controls, it would devastate a country’s banking industry,” says Bishop. It’s reasons such as that which have believers in the euro project hoping the current upsets are just teething troubles. ■

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CRISIS REOPENS RIFT BETWEEN NEW AND OLD EUROPE he EU crisis has crystallized a long-simmering debate between its members over what the Union needs to do to cope with looming challenges to once high-flying economies. In one corner stands UK Prime Minister Tony Blair and his allies, largely Nordic; in the other, the French and other southern European nations.

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The “herring eaters,” as EU insiders term them, argue that high wage costs, rigid labor markets and bloated welfare systems mean that European counties will be unable to respond to the competitive challenges presented by China and India. The “pasta eaters” agree that reform is needed but are unwilling to tear up the post-World War II social model that had delivered such prosperity across the Continent. “The French referendum makes it particularly hard for the EU to push ahead with economic reform and enlargement,” says Charles Grant, director of the Centre for European Reform, a London-based think-tank. “Many will interpret the ‘non’ as a vote against liberalization and further accessions.” Wim Kok, the former Prime Minister of the Netherlands, says: “We run a risk of a reform standstill. Every government should realize that the market will not be waiting. We would be stupid if we were to allow ourselves to stagnate rather than reform.” Kok chairs the EU’s high-level group on the Lisbon Strategy, a set of targets for making the EU’s economy more flexible, competitive and knowledge-based by 2010. The second half of a progress report by Kok’s group, the first part of which was published earlier this year, is substantially behind schedule.

THE SILVER LINING While it has prompted a whole rash of hand wringing, the recent crisis might not, in fact, spell the demise of the EU and all its stands for. In the turmoil left in the wake of the twin “no” votes, optimists are finding the opportunity to inject new vigor into the reform process. “Rejection of the treaty should be treated as an opportunity rather than a threat,” says Sally McNamara, European Union project director for the American Legislative Exchange Council, a Washington, DC-based association of state legislators. “An opportunity for Europe to address the high-tax, low-growth environment that has stifled the mainland economy for so long.” Reformers are pinning their hopes on a new generation of politicians. French President Jacques Chirac’s term ends in less than two years, and it is likely he will be replaced by the dynamic Nicholas Sarkozy. In Germany federal elections this September look almost certain to usher in a new right-wing government under Angela Merkel. Merkel, a 50-year-old woman from the former East Germany, certainly breaks the mold and has talked of the need to make painful adjustments. She may not prove quite the ally that Britain’s Tony Blair hopes she may, though. “Merkel is no Thatcher,” says Derek Scott, a former economic adviser to Blair, referring to the British Premier who fought unions, tore up labor laws and sold off state companies. Scott points out that Merkel’s coalition partners are the CDU, the Catholic party, which rules Bavaria. While largely pro-business, the party has a strong commitment to the social safety net that has surrounded Germany’s citizens since the 1960s. And Sarkozy, while a reformer, has a strong streak of old-style Gaullist statism running through his thinking. Anglo-Saxon reformers, it seems, may be lonely for some time to come.

A new political generation: French Interior Minister and potential successor to Jacques Chirac, Nicholas Sarkozy (left), has taken on the labor unions in an effort to improve the French economy. German chancellor candidate, Angela Merkel (right), has been likened to Britain’s Margaret Thatcher.

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REGIONAL REPORT EUROPE

BY ANITA HAWSER

The Beginning of the End Game

Countries that have failed to reform their labor markets will soon find they have no choice but to bite the bullet.

ne only has to look at the newspaper headlines splashed across the business pages of European newspapers these days to realize that something is amiss

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in the state of Euroland. With France and the Netherlands saying “no” to the proposed EU constitution, which saw the euro tumble to its lowest levels against the US dollar in months, it

wasn’t long before headline writers posed the question,“How long can the euro last?” Comments by Italian welfare minister Roberto Maroni that Italy should return to the lira hardly

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helped and prompted some obser ver s to contemplate the unthinkable: the exit of countr ies from the euro. Maroni, like many other euro-skeptics, blames poor economic growth, lack of competitiveness and high unemployment on the lackluster performance of the euro. And with the aftershocks of the “no” vote still resounding across the market, stockbrokers also indulged in a spot of speculation, with UK-based stock bro-

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the larger economies—France, Germany and Italy—have their share of problems.When compared with fastergrowing economies such as China and India, the eurozone has certainly under-performed. A Centre for Policy Studies (CPS) paper entitled “Four Economic Blocs,” published in February this year, points out that while China’s economy grew at an annual average rate of 8.25% from 1996 to 2005, India’s at 6%, and the US at 3.5%, the EU-15 grew by less than 2.5%. From 1996 to 2005 the “big three” eurozone economies grew at an average rate of 1.6%, compared to the

2004), according to Eurostat. At the same time, the Italian economy skidded into “technical recession,” with first-quarter growth of -0.5% compared to -0.3% in Q4 last year. EU ministers have expressed concerns at the divergent growth rates within the EU, but Rolf Elgeti, head of European equity strategy at ABN AMRO, says it is not cause for concern. “If you look at the US, there are huge divergences in growth and inflation between the various states,” he says. Perhaps what is more symbolic of the “sickness” that pervades the major eurozone economies is the high rate of unemployment—10.2% in France, 11.8% in Germany and 8% in Italy. In its 2005 Economic Outlook, the OECD predicts that EU unemployment will remain high, at 8.5%. Another bone of contention, at least among consumers, is that the euro has fueled higher prices in the eurozone. Inflation has remained above the European Central Bank’s (ECB) target of 2%, rising to 2.5% in May last year. Rising oil prices have also taken their toll. “Ask the man in the street, and he will say the problem with the euro is that when it was introduced, the price of a number of everyday goods across the eurozone increased significantly,” says SG’s Marcussen. “Some people feel their standard of living [post-euro] has declined.”

“THE MAN IN THE STREET WILL SAY THE PROBLEM WITH THE EURO IS THAT THE PRICE OF EVERYDAY GOODS HAS RISEN” “Some people feel their standard of living [post-euro] has declined.” —Michala Marcussen, SG Asset Management kerage company Charles Stanley Sutherlands postulating that by 2020 complete collapse of the eurozone was “inevitable.” Economists, however, maintain that the costs of leaving the euro far outweigh the benefits. “If Italy were to leave the euro today and devalue by, say, 15%, this would come at the cost of significantly higher interest rates, placing an additional burden on the already very weak Italian public finances,” says Michala Marcussen, head of strategy and economic research at SG Asset Management. Paul Mortimer-Lee, global head, market economics, BNP Paribas, says the legal issue associated with countries’ quitting the euro would make the cost of exiting extremely high. He concludes that there is little probability of a country leaving the euro. The eurozone countries, particularly

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UK, which grew by 2.7% (see table). Economic recovery within the EU remains sluggish, with the OECD predicting that growth would slow from 2% in 2004 to 1.25% this year. Economic growth rates also diverge greatly across the eurozone and the “big three.”The German economy appears to be emerging from a difficult economic period, reporting growth of 1% in the first quarter of this year (up from -0.1% in the fourth quarter of

Structural Rigidities With consumer demand at its lowest levels, there is increasing pressure on ECB president Jean-Claude Trichet to

AVERAGE ANNUAL GDP GROWTH RATES 1996 TO 2005, AND DIFFERENTIAL GROWTH RATES BETWEEN THE UK AND EUROZONE

Average growth rate (%) Differential growth rates (%) GDP in 2005 (1995 = 100)

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Source: OECD, Economic Outlook, Volume 2004/1, June 2004. Published in the CPS Perspective

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GERMANY TAKES PAINS TO LOWER LABOR COSTS ith unemployment exceeding 10%, Germany has been a prime candidate for labor market reform. In the past two years the government instituted the Hartz I through to Hartz IV reforms, aimed at creating new jobs and reducing the bureaucracy entailed in finding employment. The most farreaching and controversial of these reforms is Hartz IV, passed by the German parliament in December last year, which will see unemployment benefits significantly cut, particularly for the longer-term unemployed.

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German economics and labor minister Wolfgang Clement expects joblessness to recede during the year

In its Global Investment Returns Yearbook 2005, Rolf Elgeti, head of European equity strategy at ABN AMRO, argues that the cost of the Hartz reforms is likely to be borne by consumers, but he believes the measures will reap rewards in the coming years. “We see these attempts as promising steps in the right direction, although more is certainly needed,” he says. In addition to government measures, German companies such as Siemens, DaimlerChrysler and Volkswagen have also instituted labor market deals, which Elgeti says puts them at the forefront of lowering labor costs in Europe. The more notable of these deals was Siemens’ reaching an agreement with employees to extend the working week from 35 to 40 hours, as well as the removal of some bonuses, in exchange for not closing down two production plants and relocating jobs to lower-cost facilities in Central and Eastern Europe.

lower interest rates. While this may provide some short-term relief, SG’s Marcussen says that monetary conditions are not the problem and that the focus on the euro is merely an attempt to divert attention away from the more difficult structural reforms that countries such as France, Germany and Italy need to implement in order to revive their economies. She says that interest rates within the eurozone are already at their lowest levels since the postwar period and that any further cuts would only come about as the result of further deterioration in the economic climate. “What Europe needs to do is remove structural rigidities and increase consumer and company confidence,” she observes. ABN AMRO’s Elgeti agrees that structural reforms are far more important than lowering interest rates. He maintains that reducing labor costs in the “big three” eurozone economies is essential for stimulating economic growth and productivity. “Europe is less competitive than other countries because of the lack of flexibility in the labor markets,” he explains, particularly as cheaper labor centers emerge in China, Central and Eastern Europe, and India. The OECD also attributes structural factors to the eurozone’s lack of resilience against “adverse

shocks” and says that further economic integration and structural reforms, such as boosting labor performance, remain “pressing.”

The Italian Job Historically, trade unions were firmly entrenched in the “big three” eurozone economies, but recent deals negotiated by German companies such as Siemens and Volkswagen to extend the working week to 40 hours without any additional compensation have shifted the goalposts. Italian companies, however, have not been as aggressive as their German counterparts when it comes to cutting labor costs.“For Italy it will be a cultural shock,” says Elgeti “as companies there are operating in the wrong sectors, and one could argue that, without the euro, circumstances could be much worse for Italy.” BNP Par ibas’ Mortimer-Lee says that a major competitive gap has opened up in Europe. Citing EU Commission figures, he says that between 1995 and 2004 German manufacturing productivity improved by more than 42%, compared to an improvement of only 6% in Italy.“An important part of Italy’s exports are textiles, clothing and shoes, all of which compete with lower cost countries such as China and Central and Eastern

Europe,” he says. “A lot of Italian firms are smaller in size so the scope for R&D to improve productivity is fairly limited.” Pointing to the example of Germany, which instituted sweeping labor market reforms (see box), Marcussen says Italy has to go through a similar, difficult period of reform to get the economy back on track, which could see unemployment and general economic conditions worsen before they get better. “The benefit of structural reforms is seen in the long-term; however, short-term the implications are often negative,” she says. Germany has certainly led the way in terms of structural reforms within the “big three” economies, although arguably more still needs to be done. France, on the other hand, is at the “halfway” mark, says Marcussen, commenting that recent measures in terms of reforming the pension system and privatization were largely positive but that labor market reforms did not go far enough. The 35-hour working week is enshr ined in French law, which Marcussen says has introduced some flexibility, as wages have not risen for several years. “The 35-hour week is not a hindrance to labor reforms,” she says, “but it hasn’t helped create new jobs.” ■

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REGIONAL REPORT: EUROPE DEBT MARKETS

BY LAURENCE NEVILLE

Caught In The Downdraft European companies are finding themselves trapped in the fallout from recent downgrades of GM and Ford. orrowers in the European bond markets have been on a rollercoaster r ide in the past four months. Having grown accustomed over the past 18 months to almost ideal market conditions, the market took a sudden turn for the worse following the downgrades of Ford and General Motors and the leveraged buyout of Danish cleaning company ISS. But as strength has returned to the new-issue market, it seems corporates are no longer taking investors for granted. The benign issuance conditions of the past 18 months have had a unique set of drivers. Regulatory changes have resulted in a move by insurance and pension funds out of equities and into fixed income. Meanwhile, the low interest rate environment globally has created a hunger for yield, increasing demand for credit.With supply low and redemptions high, the market was well bid. As Stuart Bell, head of European DCM at ABN AMRO in London, notes, most corporate treasurers had become apathetic about market conditions. “They had been constantly told that issuance conditions were at the peak, but the predictions hadn’t become true, and consequently there was less urgency to issue,” he says. But in early March the technical conditions that had created that situation ground to a halt.“Everyone was fairly fully invested,” he says.

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When GM’s earnings warning—the precursor of its downgrade—came on March 16, it created a change in sentiment that was more severe than most anticipated.“It began a spiral for the debt markets which it took until the end of May to recover from,” says Jean-Francois Mazaud, head of corporate origination at SG CIB in Paris.“The negative sentiment was fed by bad news for almost two months—first from GM and Ford, then by the downgrades and their removal from investment-grade indexes.” The second event to shock the market was a complete surprise: the €3.85 billion LBO of Danish company ISS by Goldman Sachs Capital Partners and EQT, the largest European bond issuer ever to be targeted, at the end of March. Spreads widened by as much as 400 basis points (4%) on the 2014 bond, recalls Mazaud.“There was an immediate reaction among investors to consider almost anything—even DaimlerChrysler—to be at risk of an LBO, and spreads widened accordingly.” Around the same time, the market decided that US rates would likely have to rise more quickly than expected. “It had an effect on the carry trade,” explains Bell. In a tightening spread environment, against a backdrop of low interest rates, it makes financial sense to borrow money to fund bond

purchases. The trade is widespread, but hedge funds tend to leverage their trades, making them more vulnerable to rate rises.

European Issuers Hold Fire As spreads widened—all of 2004’s spread tightening unwound in just one month—and market rates

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moved upward, the outlook for such investors suddenly looked pretty bleak, and certainly no one wanted to buy new issues. Inevitably some corporates were caught out by the sudden change in sentiment. Some, such as German automotive and defense company Rheinmetall, chose to delay their issues. But others, including Austrian brickmaker Wienerberger and Swiss pharmaceuticals firm Syngenta, pressed ahead and had to pay up for their decision.They were in the market during the week of April 11, and as investors got more skittish over the prospects of LBOs, the borrowers were forced to include change-ofcontrol covenants in their bonds, which would guarantee investors a put at par in the event of a takeover. For debut is-

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suer Wienerberger, the change-of-control clause was a price worth paying to diversify its funding base away from banks in Austria and Germany. “Even with the change of control, the bond market is still very flexible relative to bank lending,” says Hans Tschuden, CFO of Wienerberger. Tschuden does admit that he wishes his bookrunners, ABN AMRO and Bank Austria Creditanstalt, had warned him of the potential need for a change of control on the €400 million seven-year deal. Syngenta was less happy to offer the change-of-control covenant as it had an existing EMTN program. But as Domenico Scala, CFO of Syngenta, notes, if a company intends to target UK-based investors, in particular, plans to issue more than €100 million and is a potential LBO candidate, then a change-of-control clause is likely to be necessary to complete a deal. Of course, market conditions can change dramatically for the better as well as for the worse. Just a month after Wienerberger and Syngenta, BASF and Sanofi-Aventis re-opened the market—albeit on investors’ ter ms. Double-A-rated BASF realized that real money accounts—pension and mutual funds—had built up cash while the market was closed and were seeking a high-quality home for it. Double-A-rated Sanofi-Aventis chose to focus even more narrowly on the demands of one group of investors and used its high A1-plus/P1 shortter m debt rating to its advantage. Among French corporates outside the banking sector only oil company Total has a similar rating, and consequently money market funds and banks were

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eager to buy SanofiAventis’s two-year €1 billion FRN. Since then the market has re-opened more widely as bonds have recovered 75% of the value lost since March. GlaxoSmithKline was able to achieve a coupon of just 4% at the beginning of June for a 20-year deal, and a slew of hybrid issues—perpetual subordinated debt that is counted as equity by rating agencies—from corporates such as the world’s biggest sugar producer Südzucker have proved that investors’ reluctance to buy lower-rated credit was an aberration. Part of the reason for this is practical: Inflows remain strong, and they have to be invested somewhere. Also, fears of a rate rise in the US have receded, meaning the carry trade is once again economical. From an issuer’s perspective the introduction of the EU prospectus directive on July 1 has been a boon to issuance.“It is concentrating issuers’ minds on their deal timetables,” says Eirik Winter, European co-head of fixed-income capital markets at Citigroup in London. “They know that if they don’t do a deal shortly, they will have to spend some time preparing new documentation and then have to wait their turn once the market opens after the summer.” In addition, treasurers have realized after the fright of the months after March that credit markets can easily turn bad and lock them out. “It’s been a rude awakening,” says ABN AMRO’s Bell. “Corporate treasurers are now cognizant of volatility in a way they were not in March. They’ve also realized that on a four-year horizon absolute yields are unbelievably low.” But the way in which issuers are approaching the market has changed. As Citigroup’s Winter notes, the new watchword among issuers—in relation to market conditions, timing or investors’ demands on tenor, pricing or structure—is responsiveness. ■

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COUNTRY FOCUS TURKEY

BY PAULA L. GREEN

Turkey Ponders Future After Euro “No” Votes Turkey’s frantic rush to conform to European standards is faltering as the EU reconsiders its own future direction.

urkey is once again poised at a crossroads politically—and perhaps economically—as its decades-long quest to anchor itself with Europe suffers another setback. Bolstered by the lowest inflation rate in more than 30 years and economic growth that almost reached double digits last year, this strategically located nation bridging Western and Eastern cultures is eager to begin European Union accession talks in October. But analysts say French and Dutch voters’ recent decision to reject the European Constitution is a sign of growing popular discontent with the EU’s rapid expansion and the competition for jobs with the swelling immigrant population. So after making a myriad of political and economic reforms over the past several years to curry favor at the EU negotiating table, Turkey finds itself needing to regroup.” “The collapse of the constitution is a

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setback for Turkey. If I were a Turk and keen on accession, these would not be rosy days,” says Charles Kupchan, a senior fellow and director of European Studies at the Council on Foreign Relations in Washington, DC.“I would be surprised if they [negotiations] were not postponed or a face-saving compromise worked out,” he adds. The possible derailment of the EU accession talks isn’t likely to stall Turkey’s economic progress, but the sudden setback may make investors less likely to sink large amounts of money into this largely Muslim nation.“While the economy is doing well and the EU issue is not fundamental to future economic growth, it makes Turkey less attractive to foreign investors,” says Kupchan.“But it’s not going to tank the economy.The EU accession would have taken years under the best of circumstances.” It has been the promise of entry into

the coveted circle of European nations that sparked many of Turkey’s recent reforms on issues from human rights violations to anti-corruption measures to fiscal reforms. These reforms in turn have given the country the political and economic stability that both local and foreign companies of all sizes crave when considering investing. “The carrot of EU membership was the catalyst for many of Turkey’s reforms,” says Omar Taspinar, director of the Turkey program at the Brookings Institution in Washington, DC. He adds that these reforms and the country’s subsequent macroeconomic stability produced a jump in foreign investment to approximately $1.5 billion in 2004. About $1 billion of that was in the banking sector.The remaining foreign dollars have typically been relatively small infusions in a variety of industries, including food and retail, telecommunications, in-

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frastructure and petrochemicals. Foreign direct investment in Turkey has rarely exceeded $1.2 billion annually, says Neeraj Jain, an official with the International Finance Corporation, even though the country offers foreign companies a large domestic market of nearly 70 million consumers, with many young people and a wide range of natural resources. “It’s somewhat of a paradox because Turkey has many of the assets that foreign investors look for,” says Jain, principal strategy officer in the IFC’s Department for Southern Europe and Central Asia. Part of the World Bank Group in Washington, the IFC promotes private sector investment in developing countries. “They’ve lost out to locations in Eastern Europe, where companies can still export to Europe,” he adds. Labor costs are rising in Eastern Europe, though, and analysts believe companies with a longer-term vision will want to look at Turkey more seriously.“It could serve as a cushion for foreign investors who want to go into new markets in Central Asia,” says Jain, adding that Turkey needs to be more aggressive in selling itself as a business location—a void the IFC hopes to fill as it helps Turkey create an investment promotion agency. “Unfortunately, Turkey has not done a good enough job of marketing itself,” he adds. The privatization of state-owned entities is another largely untapped area for both the Turkish government and foreign investors. The government has been distracted from any major privatization program by issues such as the EU accession talks and the IMF stabilization program, as well as unclear lines of responsibility among government ministries, Jain says. “There’s no shortage of candidates. But the responsibility and accountability between ministries has not been clear,” he explains, adding that officials are now developing the proper regulatory framework for selling off stakes in government-owned companies. According to

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World Bank officials in Ankara, about two-dozen companies are scheduled for sale this year, ranging from Türk Telekom and TPAO, the petroleum company, to Erdemir, an iron and steel company. Jain agrees that a slowdown in the EU integration process is unlikely to seriously affect the Turkish economy. Most analysts expect growth of at least 5% in the next several years, with inflation remaining in single digits. “I think the reforms in Turkey are internally driven, by the people and by the businesses,” he adds. Turkish officials are working with the IMF and the World Bank on making the structural reforms—whether revamping

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sounder financial footing of the economy and the banks themselves has encouraged banks to expand their retail banking activities. Lending to small and mid-size businesses, as well as consumers, is on the rise, and analysts say other banking segments with potential include pension funds and asset management. “In the past, the corporate market was the only one to lend to,” says Neslihan Tombul, managing director and senior representative in the Bank of New York’s Istanbul office. “Now that has changed, and banks are developing relationships with small and mid-size businesses. Banks are holding the hands of their clients

TURKEY “COULD SERVE AS A CUSHION FOR … INVESTORS WHO WANT TO GO INTO NEW MARKETS IN CENTRAL ASIA” “Unfortunately, Turkey has not done a good enough job of marketing itself.” —Neeraj Jain, principal strategy officer in the IFC’s Department for Southern Europe and Central Asia the tax and social security systems or trimming the budget deficit—that will give the country long-term macroeconomic stability.

Banking Banking is one sector in which the Turkish government has already made enough serious reforms to attract foreign investment. Ironically, it was the nation’s banking sector that helped kick off a financial crisis in early 2001 that forced officials to sharply devalue the local currency, the Turkish lira. Inflation soared to more than 50% as the economy contracted by 7.4% that year. Since then, banking regulators’ efforts to clean up the financial system have resulted in a reduction of the number of banks from about 80 to around 50 and helped to lower the cost of funds. The

when times are tough, and in 10 years they’ll have a real relationship.” Tombul, who is the senior credit marketing officer for the bank’s operations in Turkey, adds that Turkish banks are also looking at the potential in selling banking products to young people. About 65% of the population in this nation of nearly 70 million people is under the age of 25. “There’s a tremendous amount of potential.Young people lack good products. They need consumer loans and credit cards,” she adds. All of these new banking opportunities have already generated intense interest among foreign banks. Some of the recent activity includes the Belgian-Dutch Fortis Group’s pending purchase of nearly 90% of Disbank from Dogan Holding, a Turkish conglomerate. If approved, this would be the largest foreign investment

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to date in the Turkish banking sector, which is relatively small, with about $150 billion in assets. UniCredit of Italy purchased 50% of Koc Bank several years ago, and the Koc-UniCredit partnership is now trying to buy 58% of Yapi ve Kredi Bankasi, which would represent an $800 million investment by the Italian banking firm.Yapi ve Kredi Bankasi has made inroads in Turkey’s growing credit card lending business. Late last year French bank BNP Paribas moved to buy a 50% stake in TEB Mali Yatirimlar, the majority shareholder of Turkish bank Türk Ekonomi Bankasi, from the Turkish conglomerate Colakoglu Group. “Foreign banks see Turkey as an opportunity. They view Turkey as an expanding economy and an under-loaned economy,” says Ed Thompson, senior director at Fitch Ratings Service in New York City.“And the size differential is substantial. So for a relatively modest amount of money, they can make an investment.”

Geopolitical Outlook Whether or not the EU-Turkish accession talks begin this October as

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Neslihan Tombul, Bank of New York: “Banks are developing relationships with small and mid-size businesses”

planned, Turkey still offers the West a strategic location—politically, militarily and economically—between Europe, Asia and the Middle East. This nation stretches from Bulgaria in southeastern Europe to Georgia in southwestern Asia and sits north of Syria and Iraq. Analysts say several political scenarios are emerging, and, in one,Turkey would align itself more closely with the US and Israel. But Bulent Aliriza, director of the Turkey project at the Center for Strategic and International Studies in Washington, doesn’t expect Turkey to turn away from its 40-year effort to integrate with Europe. “It’s not an ‘either

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or’ situation.The relationships [with the EU and the US] are complimentary, “ says Aliriza. On the economic front, the US is too far away geographically to pick up the strong trade and investment ties that European companies have traditionally enjoyed with Turkey, says Aliriza. And since the US invasion of Iraq, US-Turkish political relations have been strained while anti-American sentiment has grown among the general population. One pessimistic view of the emerging political situation holds that Turkey— with its large Muslim population— would align itself with the East.“There’s a geopolitical uncertainty,” says Kupchan of the Council on Foreign Relations. “Some wonder whether the nationalistic and Islamic forces will become stronger as a result of a sense of rejection by the EU.” Jain argues that Europe needs Turkey more than Turkey needs Europe. “Both from a geopolitical standpoint and economically, they add to Europe…bringing natural resources, labor and new markets,” Jain says. “The EU should be desperately wanting Turkey.” ■

BEST COMPANIES IN TURKEY, 2005 urkish companies of all sizes are reaping the rewards of the country’s newfound macroeconomic and political stability— and its strengthening ties with Europe. The solid economic numbers have boosted consumer demand and sparked new investment as borrowing rates head downward and Turkish banks begin building stronger relationships with small and mid-size businesses. Global Finance selected 10 sectors that represent a cross section of a Turkish economy that grew by nearly 10% last year. We chose traditional sectors such as textiles and agriculture that, while contributing less to the gross domestic product, are still re-

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AGRICULTURE Haci Omer Sabanci Holding This giant Turkish conglomerate commands a major presence in the Turkish food sector through Gidasa and its subsidiary, Marsa. Set up in 2002 as a multi-food business company to foster growth for the Saban-

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sponsible for employing large segments of the country’s rural population; industrial areas such as autos and iron; and the fastgrowing services sector, where industries including telecommunications, tourism and other services are contributing more than half of the country’s gross domestic product. The top company in each category was chosen using research and input from financial analysts, consultants, company executives and business leaders both in the United States and in Turkey. The criteria included an objective and subjective mix of assets, profitability, strategic and expanding relationships, customer service, innovation and management savvy.

ci Group, Gidasa expects annual sales to reach $400 million this year as it keeps buying and expanding. Last year, Gidasa expanded the portfolio of food products sold under its Piyale brand and created two new business units, Gidasa Beverages and Gidesa Farm. It also bought Omur,

another well-known and senior brand of Turkish foods.

AUTOMOTIVE Tofas (Türk Otomobil Fabrikasi AS) Created in 1968 as a joint ItalianTurkish venture to manufacture passenger cars and light commercial ve-

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hicles at a plant in Bursa,Tofas today is Turkey’s leading carmaker, supplying about 40% of the automobiles made in the country. The company is jointly controlled by Turkish conglomerate Koc Holding and Italy’s Fiat Group and listed on the Istanbul Stock Exchange. Net sales totaled $1.87 billion last year while net income reached $24.1 million.

BEVERAGE Efes Beverage Group Part of the Anadolu Endustri Holding conglomerate, the Efes Beverage Group produces and markets beer, malt and soft drinks across a wide region that stretches from Turkey to Kazakhstan to Serbia. The giant beverage company has more than a dozen breweries, four malt factories and nine Coca-Cola bottling facilities in nine countries. Its leading beer and international brand—Efes Pilsner—has captured nearly 80% of the local market.

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Company sales topped $1 billion last year while net income totaled $236 million.

CONGLOMERATE Haci Omer Sabanci Holding A vast sprawling conglomerate with annual sales of $12 billion, the Sabanci Group has interests in about 70 companies that span dozens of industries from financial services to cement to autos to textiles. At the helm of this family-owned business is Guler Sabanci, the niece of former Sabanci leader Sakip Sabanci, who died last year at the age of 71. The company operates in about a dozen foreign countries and has partnerships with a variety of international firms, including Carrefour, Dupont and Philip Morris.

CONSTRUCTION Dogus Construction Group Part of the Dogus conglomerate, the Dogus Construction Group is one

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of Turkey’s largest construction companies and is well known around the world for having a hand in everything from giant hydroelectric power plants to tunnels to consulting services.The company is best known in Europe for its highway and dam projects and completed the main route of the Trans-European Motorway that connects Turkey to Europe.

ENERGY Turkish Petroleum Corp. (TPAO) As an integrated oil company engaged in activities ranging from exploration to refining, state-owned Turkish Petroleum cannot be ignored. The company has an ambitious plan to meet all of Turkey’s oil and natural gas needs as well as to bolster its bottom line with overseas projects in places such as Libya and Kazakhstan.The company also has a 6.5% stake in the $3.6 billion BakuTbilisi-Ceyhan pipeline that just be-

BEST BANKS IN TURKEY, 2005 urkish banks are benefiting from a stronger Turkish economy and banking regulators’ recent efforts to streamline and clean up the nation’s banking industry. New opportunities are emerging in banking segments from retail services to credit card lending to asset management. The sounder financial footing of the economy and the banks themselves—asset quality is up as the banks post greater profits—is generating intense interest among foreign banks. Several European banks have already tapped into opportunities in the local banking market by purchasing stakes in Turkish banks. Global Finance selected five sectors that represent some of the

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BEST COMMERCIAL BANK IN CORPORATE SERVICES Akbank One of the largest private commercial banks in Turkey, with about 11% of the nation’s banking assets, Akbank provides a variety of corporate services, from traditional lending to foreign exchange trading. This Istanbul-based bank focuses on

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more traditional banking services—such as commercial services for corporations—of Turkey’s universal-type banks, as well as new growth areas such as the growing credit card lending business. In order to compile the complete list, the top financial institution in each category was chosen using research and input from financial analysts, consultants, bank executives and business leaders both in the United States and in Turkey. The criteria used to determine the winners included an objective and subjective mix of assets, profitability, strategic and expanding relationships, customer service, innovation and management savvy.

using technology and strong risk management techniques and is beefing up the training of its staff to improve relations both with its corporate and with its retail clients. Majority-owned by the giant Sabanci Group, this financial institution has a strong capital base and a well-known brand name throughout Turkey. Assets totaled $26.4 billion at the end of 2004.

BEST COMMERCIAL BANK IN RETAIL SERVICES GarantiBank GarantiBank is majority owned by Turkey’s Dogus Group and is one of this nation’s largest privately owned commercial banks. The bank is known for a progressive management style and innovation that has made it a pioneer in everything

COUNTRY FOCUS

gan carrying crude oil from the Caspian Sea in Azerbaijan to the Mediterranean terminal at Ceyhan in Turkey.

IRON & STEEL Erdemir (Eregli Demir Celik) Erdemir is Turkey’s largest iron and steel company and its only integrated steelmaker. It has an annual production capacity of 3 million tons of crude steel and an ambitious plan to more than double that capacity by the end of 2007. Foreign companies are watching the government’s plan to sell off its 46.1% stake in the company this year. About 3% of its shares are held by the Turkish Development Bank while the rest are owned by Turkish Halk Bank or publicly traded on the Istanbul Stock Exchange.

TELECOMMUNICATIONS Turkcell Turkcell is Turkey’s largest mobile

from online banking to implementing scoring systems in its consumer loans and credit cards. Today, the bank is a leader in retail banking, a growing segment for the banking industry in Turkey.

BEST BANK IN CREDIT CARD LENDING Yapi ve Kredi Bankasi Credit card lending is one of the fastest-growing segments in the Turkish banking sector, and Yapi ve Kredi Bankasi is a leader in this market.The bank is successfully using its strong brand name, a network of more than 400 locations throughout Turkey and top-notch customer service to build a loyal base of credit card clients.The bank’s fortunes can only improve with the decision by UniCredit and Koc Holding to

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phone company. Its customer base has grown tenfold in the last seven years to more than 23 million subscribers. The innovative company is positioned to take advantage of the country’s fast-growing cell phone market of 35 million users—nearly double the number of fixed-line subscribers. Turkcell is listed on the New York and Istanbul stock exchanges, and revenue jumped by 44% to $3.2 billion in 2004 while net income more than doubled to $511.8 million for the year.

TEXTILES Zorlu Holding Zorlu Holding Textiles Group is one of Turkey’s largest producers and exporters of home textiles and one of the primary four business areas of Zorlu Holding, another of Turkey’s giant conglomerates, registering annual turnover of about $4 billion. Zorlu Holding Textiles Group has nearly a dozen textile plants in loca-

team up and buy the controlling 57% stake owned by the troubled Cukurova Holding company.

BEST FOREIGN BANK Citibank This financial giant has been a player in the Middle East region for half a century and has the longest history—more than two decades—of any foreign bank in Turkey. The bank is committed to expanding its presence in the country, and more than 1,000 employees work to offer corporate and retail clients a full array of financial services. These services include credit cards, Internet banking and retail banking for Citibank retail customers and corporate and investment banking services for the bank’s domestic and cross-border corporate clients.

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tions from Turkey to France to Iran and is a major exporter. Its TAC brand is a leading textile name known around the world.

TOURISM Koc Holding Run by one of Turkey’s wealthiest dynasties, Koc Holding is a giant diversified conglomerate that spans more than a dozen industries and nearly 100 companies. Koc Tourism’s contribution to overall company profits has increased in recent years as all of Turkey’s conglomerates tap into the country’s popularity on the world travel map. Koc Tourism is involved in every aspect of the travel business—from hotels to car rentals to online reservations through its “bookinturkey.com” portal. About 4.5 million people buy duty-free goods through Koc’s operations at the country’s airports and on the national airline. —PG

BEST INVESTMENT/ SECURITIES BANK Oyak Securities Major ity-owned by the Ar med Forces Pension Fund, Oyak Securities provides a wide range of investment banking and brokerage services to domestic and international clients. Backed by a strong equity and macroeconomic research department and a network of more than 50 offices throughout Turkey, this securities firm operates in the secondary market on the Istanbul Stock Exchange. The firm trades a variety of financial instruments—from equities to government bonds to mutual funds.And the corporate finance team provides advisory services for privatization projects, merger and acquisition activities and public offerings. —PG

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REGIONAL FOCUS ASIA

BY ANITA HAWSER

ASEAN Countries

lobal trading volumes have skyrocketed in the past 50 years since the World Trade Organization first began its quest to demolish trading barriers. As developing countries such as China, India, Cambodia, Laos and Vietnam open their markets to for-

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eign investment, trading volumes will continue to rise. The Association of South East Asian Nations (ASEAN) is hoping it can drive further growth in regional trade and integration. The driving force behind free trade agreements is usually the idea that free

trade promotes higher levels of economic integration and cooperation between regions. In reality, however, free trade agreements (FTAs) are often difficult and time consuming to implement, and there are questions around who really benefits from them.

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ASIA

Find Joy in Unity South East Asia’s regional trade alliance is looking for ways to promote intra-regional cooperation without reducing its members’ competitiveness.

market-based economies. The 2002 trade dispute over the United States’ imposition of tariffs on steel imports in an effort to stem local job losses is a reminder that countries are only willing to open their markets so far and that the political will needs to exist for FTAs to be faithfully applied. Implementing FTAs may be challenging, but they are considered to deliver clear economic benefits for those countries that can make them work. Studies by the Centre for Economic Policy Research show regional free trade deals between EU countries, for example, or the US, Canada and Mexico (NAFTA) can boost trade and economic growth. In the EU, consultant McKinsey says less-developed countries such as Ireland, Portugal and Spain gained more from EU membership in terms of higher levels of economic growth. Similarly, studies indicate that

newer entrants, Cambodia, Laos, Vietnam and Myanmar, are hoping to emulate their success. Combined, the 10 member countries constitute a market of 500 million people with a combined GDP of $600 billion, the largest Asian consumer market in terms of value outside of China. In addition,ASEAN is also home to 40% of the Asia-Pacific’s oil and gas resources.

Caught Napping ASEAN came into being in 1967 as a means of promoting peace, progress and economic prosperity across the region.At its fourth summit in Singapore, in 1992, the ASEAN Free Trade Area (AFTA) was born, with the aim of promoting the gradual phasing out of regional trade tariffs. The agreement has since been extended to include elimination of non-tariff barriers, liberalization of trade in services and intra-

“FOREIGN INVESTORS INCREASINGLY SEE ASEAN AS A SINGLE MARKET AND PRODUCTION BASE ” “Everybody wants ASEAN to get in the game and not be left behind.” —Martin Hutagalung, US-ASEAN Business Council

Opponents often claim it is the larger developed countries with more sophisticated and powerful industrial conglomerates while supporters assert that it is the developing countries looking to make it onto the first rung of the ladder in their bid to become global

Mexico’s economic growth has accelerated since it joined NAFTA. ASEAN countries have been watching other regions’ progress with interest. Now, the six or ig inal signator ies, Brunei, Indonesia, Malaysia, the Philippines, Thailand and Singapore, and the

regional cooperation on intellectual property rights. But almost 40 years after the birth of ASEAN, the global economic landscape is much altered. Low-cost manufacturing centers in China and India have emerged, which means ASEAN can no

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Council announced that, after a decade, AFTA had been “virtually realized,” with regional tariffs on 99.6% of products in the Common Effective Preferential Tariff (CEPT) Inclusion List in the ASEAN-6 countries being reduced to within the 0%-5% range. Only 247 tariff lines within the region remained outside the remit of CEPT. The Council also announced that uptake of CEPT in the newer ASEAN member countries (Vietnam, Cambodia, Laos and Myanmar) was keeping pace with the original members, with inclusion lists comprising 72.22% of the total number of tariffs, compared to 64.27% in 2002. More than 60% of products they traded within the region were within the 0%-5% tariff band. The target for all ASEAN-6 countries to reduce tariffs on imports to zero is 2010.The newer ASEAN countries have until 2015. A number of ASEAN countries have also instigated FTAs with countries outside the region, notably Australia, China, South Korea, Japan and the United States. In November 2002 ASEAN signed a Comprehensive Economic Co-operation Framework Free Flowing ASEAN has not been resting on its Agreement with China, which focuses laurels, though. Since the 1997 crisis, the on liberalization of trade, services and original six AFTA signatories agreed to investment, as well as economic cooperspeed up tariff reduction. At Phnom ation. Japan is also looking to secure an Penh in September 2003, the AFTA economic partnership agreement with the ASEAN countr ies, which includes an FTA. The framework agreement with China also includes an ASEAN-China FTA (ACFTA), which seeks to reduce both normal and “sensitive” tariffs, with different implementation schedules set for the ASEAN-6 and the newer countries. By January 2007 the ASEAN-6 Joseph Tan (left): “The newer ASEAN countries and China hope to have are struggling to be on an even footing” reduced 60% of normal Masahiro Kawai (right): “A single common market tariffs to 0%-5%. Howevmay be difficult in the short run” er, 150 tariff lines could longer compete on labor costs alone. In addition, the region is still reeling from the economic cr isis of 1997, which, says McKinsey, caused FDI to fall by 66% and aggregate economic growth to decline by 50%. According to the ASEAN Surveillance Co-ordination Unit, from 1996 to 2002 the former Asian “tiger” economies’ average annual growth of GDP was 1.8%, compared to 7.8% for China. Exports grew at an annual average rate of 1.5% in the “tiger” economies, compared to 13.1% in China. While China surges ahead, ASEAN has been caught napping. In terms of increasing productivity, reducing costs across the region and increasing foreign investment, Adam Schwarz and Roland Villinger, consultants in McKinsey’s Bangkok and Singapore offices, believe that further trade liberalization and regional economic integration is needed. “ASEAN must find the political will to reduce further the tariffs and non-tariff barriers that raise the cost of doing business across the region’s borders,” Schwarz and Villinger reported.

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still be in place by 2010, and reduction of tariff lines on the “sensitive” list may not occur until 2018 or 2020 for the newer ASEAN countries.

Working Together In addition to liberalizing trade, in 1997 ASEAN outlined its Vision 2020 for achieving closer economic integration and narrowing the gap in development between countries such as Singapore and Thailand and Cambodia and Laos. In a recent paper on the evolution of ASEAN FTAs, Hadi Soesastro, executive director and senior economist at the Center for Strategic and International Studies (CSIS) in Jakarta, stated, “[ASEAN’s plans] to deepen economic integration amongst its 10 members is a major undertaking in view of the big differences in levels of economic development and openness.” The ASEAN group of countries realize that if they want to attract outside investment, they need to put aside their competitive differences and work together. “Foreign investors increasingly see ASEAN as a single market and production base,” says Martin Hutagalung, manager, ASEAN/APEC affairs, at the US-ASEAN Business Council, based in Washington. “It is quite challenging though,” he adds, pointing to the newer ASEAN countries such as Laos, Cambodia and Vietnam, which are still in the initial throes of becoming marketbased, outwardly focused economies. “Everybody wants ASEAN to get in the game and not be left behind. The ASEAN signatories have to find a way to help the four newest member countries develop,” says Hutagalung. But can all countries within ASEAN equally benefit from free trade? Joseph Tan, an economist with Standard Chartered Bank in Singapore, believes that to get to that stage, various countries have to have the same pace of economic development, and in this sense “Singapore and Thailand are further up the scale than countries like Vietnam and Cambodia, which are struggling to be on an

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AVERAGE AFTA/CEPT TARIFF RATES 12 10

Brunei

Malaysia

Thailand

Indonesia

Myanmar

Vietnam

Laos

Philippines

ASEAN Avarage

8 6 4

2 0 1998

1999

2000

2001

2002

2003

Source: ASEAN Secretariat Note: The average CEPT tariff rate for products in the inclusion list was approximately 2.7% in 2003.

even footing,” he says. Although FTAs may have helped goods—and to some extent services and investment—to flow more freely, ASEAN still does more trade with countries outside the region. Although intra-regional trade may have increased since 1992, when AFTA was first implemented, McKinsey says from 1994 to 2001 intra-reg ional trade within ASEAN countries as a proportion of total trade fell by 19%. Some estimates put ASEAN’s trade with other ASEAN countries at 23%, compared to 62% of EU trade, which is intra-EU.

Protectionism Persists Although 99% of tariffs on the inclusion list in the ASEAN-6 countries are at relatively low levels, some countries still exercise “protectionist” policies when it comes to sensitive products. Malaysia, for instance, continues to protect its domestic auto industry manufacturer Proton from foreign competition by imposing tariffs on imports (see Malaysia Focus, page 40), and the Philippines continues to stand firm on its imposition of tariffs on rice imports, which it has exempted from full-scale liberalization. Masahiro Kawai, economic adviser to Asian Development Bank president

Haruhiko Kuroda, stresses that while most countries within ASEAN realize they must liberalize trade, some have “weak spots” in their economies. “Take the EU and agriculture,” he says. “Not all countries, even developed ones, liberalize completely. Most of the [ASEAN] countries have weak spots, but they agree that they are going to liberalize.” Malaysia may still protect its automotive industry, but Hutagalung says it has agreed to lower tariffs to between 0% and 5% by 2010. One of the biggest cr iticisms of ASEAN is that, as it is a governmentled trade group that works on the basis of consensus, it has neither the power nor the resources to effectively coordinate and monitor implementation and compliance across the 10 countries. “The ASEAN Secretariat is unable to push for the common goal of 2010,” says Tan, “as they don’t have the political or financial muscle to push through these developments.” Many tariffs have been lowered, but other non-tariff areas still need to be tackled, including the lack of standardized customs procedures across the ASEAN. Efficiencies could be gained from harmonizing product and technical regulations and testing and licensing procedures. Some industry associations

ASIA

are also concerned about the pace at which countries are working to liberalize certain areas. The Malaysian Plastic Manufacturers Association, for example, has called for the total elimination of tariffs on resin earlier than the 2010 deadline. Soesastro of CSIS in Jakarta says it is in the interests of ASEAN and China to try to accelerate the ACFTA process, but, he adds, the “political will” has to be there for this to happen. He says ACFTA is only the first step in what could be a protracted process, as negotiations around liberalizing services and investment could prove tricky. Despite higher levels of economic cooperation across the region, ASEAN remains a collection of disparate markets. The flow of goods may be freer, but as Tan points out, the lack of free mobility for labor and capital still makes it difficult for foreign investors to do business in the region.“There are a lot more hidden costs of doing business in a region as diverse as ASEAN,” he says. Hutagalung sounds a more optimistic note, saying that if the “political will” is there, ASEAN’s 2020 vision can be realized. But for a true “single market” to be realized within ASEAN, along the lines of the EU, for example, Kawai of the ADB says the ASEAN countries need to attain similar levels of economic development, including income, standard of living and market infrastructure and institutions, something that does not exist today, although he is heartened by economic growth inherent in Vietnam and Cambodia’s entry into the WTO. “Low-income countries are catching up,” he says, “but a single common market like the EU may be difficult in the short run.”And although trade, FDI and macroeconomic interdependence are dr iving economic integ ration across the region, Kawai says this has not filtered down to the institutional level. “Institutional harmonization and integration is the next step,” he says, “and FTAs are one important instrument for achieving that.” ■

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BY JOACHIM BAMRUD

Brazil’s Trailblazers Continue to Drive Innovation in ADR Market Despite political turmoil at home, many American Depository Receipts (ADRs) of Brazilian companies are doing well, thanks to strong liquidity in the United States. But volatility is also hurting many stocks.

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ose Marcos Treiger, head of investor relations at Brazil’s petrochemical giant Braskem, is a big fan of ADRs. He has seen firsthand the positive results the ADR-issues have brought—first to pulp producer Aracruz in 1992, where Treiger worked as an investor relations officer, then again at Braskem last year. On September 22 of last year Braskem raised $281.5 million after issuing 9 million depository receipts in New York. “This became the most important and biggest equity offering by Brazil in 2004,” says Treiger, who is also a former president of the Brazilian Institute of Investor Relations (IBRI). The ADR issue actually had more demand, with total interest worth $1.9 billion, thanks to an ambitious road-show that included 110 meetings in the United

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States, Europe, Argentina and Brazil. Treiger believes part of the reason for the issue’s success was that the company rented a private jet to bring the executives to meet with investors. “We were everywhere whenever possible,” he says. Braskem’s ADR (BAK) was among the five best-perfor ming ADRs on the NYSE last year and the overall best performer in 2003. The Braskem ADR was officially listed in September 2003 after it replaced the ADR being held by Copene. Braskem is the result of the merger of various petrochemical companies, including Copene. Thanks to the capital raised last year, Braskem was able to reduce its debt, while raising its international profile. “You can see how important the ADRs are to [that] success,”Treiger says. Alexandre Q. Fernandes is another

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$155.49 in the 52-week period ended on June 30. In the first six months of this year it gained 13%. The increase is due to a combination of factors, including significant revenue and earnings growth by the companies, increased confidence in Brazil’s macroeconomic policies and economic outlook and growing liquidity among US investors. The index includes 34 Brazilian companies, all of which are listed on the NYSE. All but five posted gains in the 52-week period ended June 30. The strongest gain was registered by Perdigao (PGA), which saw a 135% increase in its ADR pr ice. Banco Bradesco (BBD) followed at 126%. Other big winners include Cemig (CIG), Ultrapar (UGP), Banco Itaú Holding (ITU), and the two companies with the most trad-

“IN THE CORPORATE GOVERNANCE LANDSCAPE, BRAZIL HAS MADE HUGE STRIDES TO BECOME MORE TRANSPARENT” “Corporate governance has been a huge topic the last two years” —Rene Boettcher, vice president at the Bank of New York and head of Latin America marketing for ADRs keen supporter of ADRs. As disclosure manager of investor relations at Petrobras, Brazil’s largest company and the second-most traded Brazilian ADR, he’s seen the company’s depositary receipts (DRs), whose symbols are PBR (common) and PBRA (preferred), skyrocket from $25.25 and $12.74, respectively, to $52.80 and $46.51 on June 28. “PBR is among the 10 most-NYSE-negotiated ADRs, and PBRA among the 20 most negotiated,” he points out. While volatility has affected some shares, overall Brazilian ADRs have gained in value and volume the past year. The Bank of New York’s Brazil ADR Index went from $84.88 to

ed ADRs—Companhia Vale do Rio Doce (RIO and RIO-P) and Petrobras. The worst decline was posted by wireless operator Telesp Celular Participações, which saw its preferred ADR (TCP) decline by 44%, followed by long-distance telephone operator Embratel (EMT), with a 23% decline, according to data from the Bank of New York. Despite Telesp Celular’s recent tumble, Charles Allen, the company’s investor relations director, remains a firm believer in the benefits of ADRs. “It’s liquidity and exposure to the international market,” he says.“I don’t see any disadvantage in having ADRs except for a slight amount of additional paperwork, but that’s it.” Under

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BRAZIL’S TOP ADRS RANKED BY DOLLAR VOLUME TRADED YTD 2005 Issue COMPANHIA VALE DO RIO DOCE—COMMON PETROLEO BRASILEIRO SA—COMMON

Symbol

Depositary

US Exchange

Industry

DRs Traded

Trading Volume ($)

RIO

MGT

NYSE

Industrial Metals

297,946,501

$9,040,022,244

PBR

CIT

NYSE

Oil & Gas Producers

171,280,397

$7,513,146,285

PETROLEO BRASILEIRO SA—PREFERRED

PBR/A

CIT

NYSE

Oil & Gas Producers

129,150,000

$4,947,532,652

COMPANHIA VALE DO RIO DOCE—PREFERRED

RIO-P

MGT

NYSE

Industrial Metals

118,502,700

$3,025,518,327

TELE NORTE LESTE PARTICIPACOES SA COMPANHIA SIDERURGICA NACIONAL—CSN

TNE

BNY

NYSE

Fixed-Line Telecom

150,322,100

$2,311,464,561

SID

MGT

NYSE

Industrial Metals

93,302,800

$1,977,923,057

UNIBANCO—UNIAO DE BANCOS BRASILEIROS S/A

UBB

BNY

NYSE

Banks

56,278,100

$1,920,294,076

EMBRAER

ERJ

MGT

NYSE

Aerospace & Defense

60,749,300

$1,904,025,568

BANCO BRADESCO SA

BBD

CIT

NYSE

Banks

53,655,700

$1,583,762,046

AMBEV—PREFERRED

ABV

BNY

NYSE

Beverages

52,617,001

$1,488,457,064

ITU

BNY

NYSE

Banks

17,646,000

$1,442,159,196

ARACRUZ CELULOSE

ARA

MGT

NYSE

Forestry & Paper

39,548,900

$1,372,764,519

GERDAU SA

GGB

BNY

NYSE

Industrial Metals

75,130,400

$1,123,349,180

BRASIL TELECOM PARTICIPACOES SA

BRP

CIT

NYSE

Fixed-Line Telecom

31,248,300

$1,031,948,143

GOL LINHAS AEREAS INTELIGENTES SA

GOL

BNY

NYSE

Travel & Leisure

27,659,800

$806,935,753

TELESP CELULAR PARTICIPACOES SA—PREFERRED

TCP

BNY

NYSE

Mobile Telecom

107,604,899

$657,893,847

VOTORANTIM CELULOSE E PAPEL SA

VCP

BNY

NYSE

Forestry & Paper

46,535,500

$605,529,677

BANCO ITAU HOLDING FINANCEIRA SA

COMPANHIA ENERGETICA DE MINAS GERAIS—CEMIG

CIG

CIT

NYSE

Electricity

21,006,100

$529,937,887

BRASKEM SA

BAK

BNY

NYSE

Chemicals

11,410,400

$458,327,697

CBD-COMPANHIA BRASILEIRA DE DISTRIBUICAO

CBD

BNY

NYSE

Food & Drug Retailers

19,292,300

$428,883,747

TIM PARTICIPACOES SA

TSU

MGT

NYSE

Mobile Telecom

24,578,500

$372,511,283

SABESP

SBS

BNY

NYSE

Gas, H20 & Multiutility

20,130,300

$272,286,922

TELE CENTRO OESTE CELULAR PARTICIPACOES SA

TRO

BNY

NYSE

Mobile Telecom

23,641,200

$244,372,415

COMP. PARANAENSE DE ENERGIA-COPEL PREF

ELP

BNY

NYSE

Electricity

37,973,500

$185,805,802

TELEMIG CELULAR PARTICIPACOES SA

TMB

BNY

NYSE

Mobile Telecom

5,902,000

$174,949,801

TELECOMUNICACOES DE SAO PAULO SA

TSP

BNY

NYSE

Fixed-Line Telecom

6,677,100

$129,287,399

CPFL ENERGIA SA

CPL

BNY

NYSE

Electricity

4,978,800

$108,483,288

ULTRAPAR PARTICIPACOES SA

UGP

BNY

NYSE

Chemicals

5,866,600

$100,765,347

Source: The Bank of New York

the Vivo brand, Telesp Celular Participações operates Brazil’s top wireless operator. The Telesp ADR was launched in November 1998 as part of the Telebras ADR, which was later split as a result of the privatization of Telebras. Geraldo Soares, investor relations manager at Banco Itaú, agrees.“The ADR initiative aims to give Banco Itaú Holding Financeira greater visibility and to encourage share trading in international capital markets, since investors the world over can now trade our shares in dollars,” he says. “This increases the liquidity and

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the upside potential of Banco Itaú Holding Financeira’s shares.” But not everyone sees the ADRs as a panacea. For Luiz Gonzaga Murat, chief financial officer of Brazilian food producer Sadia, having an ADR is a doubleedged sword. “Our program was launched … in order to access the American equity market and open the possibility of Sadia participating in the most developed worldwide market,” he says. While that is clearly an advantage, information disclosed in relation to the ADR can reach the company’s competitors. Sa-

dia also has to bear extra costs simply to have an ADR, although it has not participated in any equity calls in the past 10 years, Murat says. Nevertheless, the Sadia executive is pleased with the result. Sadia’s Level II ADR (SDA) has traded a daily average of $679,672 in the first quarter of this year. That’s more than twice the average for all of 2004. However, its value declined from $66.05 at the start of this year to $19.54 in early trading on July 1. The ADRs provide access to significantly larger markets than local stock ex-

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POLITICAL SCANDAL SHAKES ADR MARKET n early June Brazilian legislator Roberto Jefferson from the Labor Party claimed that President Luiz Inácio Lula da Silva’s Workers’ Party (PT) paid lawmakers money to support the coalition government. Lula has denied wrongdoing, but four of his top aides resigned by mid July: chief of staff José Dirceu, PT secretary general Silvio Pereira, party head José Genoino and PT treasurer Delúbio Soares.

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Dirceu, whose resignation triggered a rally in Brazilian ADR prices

Lula has vowed to investigate fully all the charges and punish whoever is guilty. Even though no conclusion has yet been reached, the scandal has dampened enthusiasm for Brazilian ADRs. Leading ADR’s such as CVRD (RIO), Gerdau (GGB), CSN (SID) and Gol (GOL) all fell during July 5 trading, mostly as a result of the growing political scandal. “The repercussions for Brazilian ADRs are somewhat mitigated by the investigation not being able to impact directly President Lula, and it’s difficult to see a scenario for an impeachment,” says Christopher Garman, a São Paulo-based analyst with the Eurasia Group. Brazilian ADRs had, in fact, rallied on the news of Dirceu’s resignation and the fact that Jefferson had been unable to present concrete evidence for his accusations.

Political turmoil at home isn’t the only factor that can weaken ADRs, though. “It’s a bigger financial market with a lot of demand, but riskier at times with very high interest rates, big surplus due to exports and currency benefits,” says Candice Teruszkin, JPMorgan’s ADR regional head of Latin America. “Globally, it’s a very attractive market—high-risk though, which can be very volatile at times with big political and economic influences on the course of the market.” Not all Brazilian companies view volatility as a disadvantage of the ADR program, though. “Volatility [is] part of the game, “ says Charles Allen, investor relations director at Telesp. “We would have that anyway. All stock exchanges are somehow connected, so I wouldn’t say additional volatility is bad or good.”

changes such as the São Paulo Stock Exchange (Bovespa), Brazilian executives and independent analysts point out.“The stock exchanges in Brazil have small volumes compared to the big financial centers,” says Pedro Roberto Galdi, a São Paulo-based analyst with ABN AMRO. That was a major driver behind the decision by Companhia Vale do Rio Doce (CVRD) to launch an ADR. The company wanted “to reach a large pool of investors and increase the company’s shareholder base,” says Fatima Cr istina, CVRD’s international spokesperson. Investors are also sometimes wary of putting their money into the local exchanges because they are concerned about regulation or other issues like currency differences, while some funds are not permitted to trade in stocks not listed on US exchanges. Bovespa, for example, is weakened by questions around minority rights, although there are re-

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form proposals to make the exchange more efficient, says Christopher Garman, a São Paulo-based analyst with the Eurasia Group. “Unfortunately, [local] capital markets are not sufficiently developed,” he says. Soares from Banco Itaú agrees.“Entering in the ADRs market, Banco Itaú had to fulfill the rules of US law that is different from Brazilian, and then we made it an opportunity to improve our controls in advance of any Brazilian legal imposition,” he says. Last year the bank created an audit committee, formed by three councilors (two independents and one external). The company’s corporate governance standards are now in line with Sarbanes-Oxley requirements. “The disclosure and the expansion of controls shouldn’t be treated as an obligation but always like an opportunity to improve all the inside process,” Soares says. Rene Boettcher, vice president at the

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Bank of New York and head of Latin America marketing for ADRs, points out that Brazilian companies—as well as public regulations—have made significant progress the past few years. “Overall, in the corporate governance landscape, Brazil has made huge strides to become more transparent. Corporate governance has been a huge topic the last two years,” he says. Brazil is the top ADR market in Latin America, with 96 ADR programs, compared with 82 for Mexico.Worldwide, it ranked third last year measured by trading value and fourth in trading volume, according to the Bank of New York. Eight new Brazilian ADR transactions raised $1.1 billion last year—almost three times as much as the capital raised in 2003.Among the most successful was the ADR launch of airline Gol Linhas Aéreas Inteligentes (GOL).

Breadth Trumps Volume While some other countries may have larger ADR volume than Brazil, the South American country is unique in that it offers such a broad spectrum of companies.“If you look at the breadth of Brazil, then it’s even more important. Finland has one or two [ADRs] or Taiwan has a huge volume out of three or four names,” says Boettcher.“That is why I think Brazil is a huge force and will continue to be.” Brazilian companies are using ADRs to receive exposure and visibility in the US market, broaden shareholder base, get more sell-side coverage, increase interest in the country through the big companies, and use ADRs as M&A currency, says Candice Teruszkin, regional head of Latin America for ADRs at JPMorgan. Because of their flexibility and liquidity, they form a useful addition to a company’s financial toolbox. Apart from ADRs, Brazilian companies typically use the Bovespa or even European stock exchanges to raise funds.Telesp, for example, lists two shares on Bovespa (ordinary and preferred) and has a program of bonds (through national and international markets) and some loans from local develop-

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ment banks, Allen says. “We’re glad to have many sources, including the NYSE, Bovespa or other markets,” he says. Allen believes the key to using ADRs successfully as part of a company’s capital-raising toolbox is to be adaptable. “It’s not static; it’s something that changes,” he says of the capital markets. “It’s difficult to say, ‘Yes, I prefer Bovespa’ or ‘Yes, I prefer ADRs.’ It’s simply a question of when you need it and how conditions are.” Brazilian companies Braskem, Sadia and pulp-and-paper-producer Suzano Bahia Sul Papel e Celulose are also listed on Latibex, a market in Madrid on which individual Latin American companies may list their shares. Braskem was first out, with a listing on October 8, 2003, while Sadia was the latest addition from Brazil, with a listing on November 15 of last year. The demand for existing Brazilian ADRs is high and has helped offset the relatively low number of new issues the past few years. Last year there were only six new issues, and the year before that,

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only one. That compares with an average of 10 during each of the previous four years. So far this year, two companies have issues two ADRs each—transportation company ALL- América Latina Log istica and online retailer Submarino in March and April. “The current state of the Brazilian market is positive,” Teruszkin says. “Currently, there is ample liquidity in the US market and local market as well.There is a favorable appetite for Brazil.” Of today’s 10 most popular ADRs, six were launched in 2000 or later. In terms of sectors, electric utility accounts for most of the ADRs (with 21), followed by telecommunications (13) and metal production and distribution (8). Despite the recent volatility, executives like Sadia’s Muzat and CVRD’s Cr istina are optimistic about their ADRs. “CVRD sees an increasing interest in the company’s shares not only from institutional investors but also by other countr ies’ individuals,” says Cristina. “So the outlook for ADRs remains very positive.”

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ABN AMRO’s Galdi believes more Brazilian companies will issue ADRs in the future. “The companies have a need, and this is a way to follow,” he says. “There is currently a cycle of new IPOs in Brazil with the expectation that they will also be listed internationally.” Some analysts, however, are less optimistic. “I see a large trend of local IPOs and less issuance of ADRs Level II or III, due to Sarbanes-Oxley and other requirements,” warns Teruszkin. “There could likely be a better chance of future Level IIIs due to the need to raise cash and a better comfort level on the regulatory front.” But independent of the continued growth or not, Brazil has reason to be proud of its ADR record, Boettcher points out. “If you look at the past 13 years—1992 was the first year when a Brazilian company made its Level III global public offering—from that moment onwards it has been only growth, every year,” he says. “In 13 years, you’ve gone from one ADR program to now almost 100.That is huge growth.” ■

BRAZIL ADR DIRECTORY BRASKEM Top line results (in Brazilian reals) 2004: Sales R$14.3 billion Net Profits: R$691 million 2003: Sales R$11.3 billion Net Profits: R$215 million Company Profile Industry Sector: Petrochemicals ADR Program: Level III Product/Service Description: Braskem produces a diversified portfolio of petrochemical products, with a strategic focus on thermoplastic resins (polyethylene, polypropylene and polyvinylchloride). While supplying petrochemical products with applications in a wide variety of industries (such as food packaging, automotive parts, paints, construction, agriculture, fabrics and personal care products), Braskem is focused on strengthening its position as a world-class petrochemical company as well as on enhancing shareholder value, with strategic drivers consisting of market leadership, cost competitiveness and technological autonomy. Business Developments Braskem S.A. is the leading petrochemical

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company in Latin America and the largest petrochemical cracker and thermoplastics producer in Brazil. Its business operations are organized into four main business units: Basic Petrochemicals, Polyolefins, Vinyls and Business Development. As the only Brazilian company with integrated first- and second-generation petrochemical production facilities, Braskem was created in 2002 as a result of the successful merger of the operations of six Brazilian petrochemical companies. Outlook The growth rate in the global demand for petrochemical products has surpassed the increase in supply of petrochemical products. In Brazil, the thermoplastic resins industry has registered a growth rate higher than that of the GDP, with a historic elasticity of approximately three times. In light of this scenario, Braskem’s strategic planning focuses on positioning the company as a benchmark in value creation for its shareholders through (1) its market leadership, (2) increasing its production scale with cost competitiveness and (3) autonomy in innovation and technology—as a distinguishing advantage in serving its clients.

Contact: José Marcos Treiger Phone: +55 11 3443 9531 Fax: +55 11 3443 9532 Email: [email protected] www.braskem.com.br COMPANHIA PARANAENSE DE ENERGIA (COPEL) Top line results (in Brazilian reals) 2004: Sales R$5.5 billion Net Profits R$374 million 2003: Sales R$4.4 billion Net Profits R$171 million Company Profile Industry Sector: Electric Power ADR Program: Level III Product/Service Description: Generation, transmission and distribution of electric power. Business Developments The company was formed in 1954 by the State of Paraná to engage in the generation, transmission and distribution of electricity, as part of a plan to bring electric power to the State of Paraná. Prior to 2001 it was a single corporation engaged in the generation, transmission and distribution of electricity and in certain related activities. In order to comply with the changed regulatory

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BRAZIL ADR DIRECTORY regime, the company transferred its operations to five wholly owned subsidiaries: generation, transmission, distribution, telecommunications and partnerships. Outlook COPEL is a fully integrated electric power company engaged in the generation, transmission and distribution of electricity in the Brazilian State of Paraná, pursuant to concessions granted by the Brazilian regulatory agency for the electric sector, ANEEL. At December 31, 2004, COPEL generated electricity at 17 hydroelectric plants and one thermoelectric plant, with a total installed capacity of 4,550 MW (approximately 99.6% of which is hydroelectric) and 3.2 million customers. COPEL hold concessions to distribute electricity in approximately 98% of the 399 municipalities in the State of Parana. As of December 31, 2004, COPEL owned and operated 6,996 kilometers of transmission lines and 165,576 kilometers of distribution lines, constituting the second-largest distribution network in Brazil. Contact: Ricardo Portugal Alves Phone: (+55) 41 3331 4311 Fax: (+55) 41 3331 2849 Email: [email protected] www.copel.com CPFL ENERGIA Top line results (In Brazilian reals) 2004: Sales (gross) R$9.5 billion Net Profits R$279 million 2003: Sales (gross) R$8.1 billion Net Profits R$-297 million Company Profile Industry Sector: Electric Energy ADR Program: Level III Product/Service Description: CPFL Energia is one of the largest private companies in the distribution, generation and commercialization of electric energy in Brazil. CPFL is the only private company in the Brazilian electric energy sector that adopted the best corporate governance practices of BOVESPA - Novo Mercado and also has a Level-III ADR on the New York Stock Exchange. The company’s strategy is focused on the improvement of operations efficiency, on the conclusion of current generation projects and pursuing new ones, on the strengthening of the commercialization business, developing new value-added products and services, and on strategically positioning the company to benefit from the sector consolidation, taking advantage of experience in integrating and restructuring other operations. Business Developments In 2004 and 1st-quarter 2005, the company accomplished many important corporate goals in order to achieve its consolidation as a Brazilian market leader. The most relevant conquests in the

related period were: ● Net profits of R$279 million in 2004 and R$166

million in Q1 2005, ● EBITDA of R$1.7 billion in 2004 and R$507 million in Q1 2005, ● Improvement of financial debt profile, ● Start-up of Monte Claro Hydro Plant commercial operations, and ● Planned Investments of R$2.6 billion on maintenance and business expansion by 2008.

Outlook The company’s overall objective is to continue to be a leading supplier of electricity distribution services in Brazil, while expanding other activities and maximizing profitability and shareholder value. The company is seeking to realize this objective through the following key business strategies: ● Focus on further improving operating efficiency, ● Complete the development of existing generation projects and expanding generation portfolio by developing new generation projects, ● Expand and strengthen commercialization business, and ● Positioning to take advantage of consolidation in the industry by using the company’s experience in successfully integrating and restructuring other operations. Contact: Vitor Fagá de Almeida, investor relations manager Phone: +55 19 3756 6083 Fax: +55 19 3756 6089 Email: [email protected] http://ri.cpfl.com.br GOL LINHAS AEREAS Top line results: (in Brazilian reals) 2004: Sales R$2.0 billion Net Profits R$385 million 2003: Sales R$1.4 billion Net Profits R$175 million Company Profile Industry Sector: Air Transportation ADR Program: 144 (a) Product/Service Description: Gol Linhas Aéreas is the only low-fare, low-cost airline operating in Brazil providing frequent service on routes connecting all of Brazil’s major cities. Gol focuses on increasing the growth and profits of its business by popularizing air travel and stimulating and meeting demand for affordable, convenient air travel in Brazil and between Brazil and other South American destinations for both business and leisure travelers. Business Developments Gol has flown more than 29 million passengers since the beginning of its operations in 2001 and, according to the DAC, Brazil´s civil aviation industry, Gol´s share of the domestic market based on revenue passenger kilometers grew to 28.8% as of the end of the first quarter of 2005.

Outlook In 2005 Gol will continue to invest in its successful low-fare, low-cost business model. Gol will continue to evaluate opportunities to expand operations by adding new flights in Brazil where sufficient market demand exists and expand into other high-traffic centers in South American countries. The addition of 13 aircraft to the fleet in 2005 will allow a 50% increase in available seat capacity. Contact: Richard Lark Phone: +55 11 5033 4393 Email: [email protected] www.voegol.com.br NET SERVIÇOS DE COMUNICAÇÃO Top line results (in Brazilian reals) 2004: Sales R$1.5 billion Net Profits -R$45.4 million 2003: Sales R$1.3 billion Net Profits -R$268.4 million Company Profile Industry Sector: Communication (pay-TV and broadband) ADR Program: Level III Product/Service Description: NET is the leader in pay-TV service in Brazil, with more than 1.4 million connected subscribers. NET’s cable network extends over 35,805 km and passes through approximately 6.7 million homes. Net also offers the Vírtua, a wideband service, and is the only cable TV company to provide the Globosat channels, being the leader in this field with a market share greater than 60% and with its client base formed by classes A and B. Business Developments Net Serviços is Latin America’s Leading pay-TV multi-operator. Net Serviços shares are traded in Brazil (Bovespa), United Sates (Nasdaq) and Europe (Latibex). Net Serviços was one of the first companies to join Bovespa’s Special Corporate Governance—Level II, affirming its commitment to the best corporate governance practices and investor relations transparency. The company’s shareholder structure counts with solid shareholders in its controlling group. Outlook Net’s operational view aims at maintaining leadership at the pay-TV segment, investing in Vírtua’s continued growth through directed marketing, and launching new packages and products. On the financial side, the company has a strengthened capital structure, directed investment, and strong controlling shareholders practicing corporate governance best practices. Net’s main focuses are client satisfaction and profitability. Contact: Leonardo Pereira Phone: (+55) 11 2111 2785 Fax: (+55) 11 2111 2780 Email: [email protected] www.ri.netservicos.com.br

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COUNTRY REPORT MALAYSIA

BY KEITH LOVEARD

Turning the Corner Long one of Asia’s more stable emerging markets, Malaysia is ready for the next stage in its development.

alaysia has much to be thankful for. Benign colonialism left the country with good education systems and sound infrastructure. A strong and vocal government under Mahathir Mohamad, who retired last year, brought plenty of criticism internationally but also the order that created an environment for strong economic development. While many developing countries wallowed in the

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doldrums, it transformed its economy from one based on plantations to one driven by manufacturing, with growth driven by exports, particularly in the electronics sector. Pro-business policies allowed rapid development in cash-rich industries— although the government itself backed some industries that still can’t compete. Capital injection into domestic infrastructure provided a strong base.

Tourism, a major income earner, acts as an introduction to increasing numbers of visitors from areas such as the Middle East to Malaysia’s services, including education and health services. And in a world of high oil prices, the country is a net exporter of both oil and gas. Currently, Malaysia is also a beneficiary of the China boom. Lee Kim Yew, head of the Malaysia-China Business Council, believes Malaysia will be

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exporting $50 billion worth of goods to the Asian economic giant within five to 10 years. This year, exports are tipped to put on 15% to reach $30 billion. At the same time, Malaysian firms are pumping cash into China’s agriculture, tourism, mining, pharmaceutical and forestry sectors. The country has not always had it easy, though. In 1989 Malaysia was hit by what became a four-year crisis, with the economy overheating due to large net capital inflows—and subsequent outflows—with high liquidity and inflation. But the economy escaped the worst of the East Asian economic crisis of 1997 that humbled many of its neighbors. Its actions to defend itself included controversial moves such constraints on capital transfers and a peg on the ringgit currency that is still in place today. Through the economic ups and downs, Malaysia’s stable political environment and educated workforce kept it moving ahead. The government had enough cash to bankroll industries that could not have survived on their own. The most prominent example is the Proton car, protected by high import tariffs on imported automobiles. Mohamed Ariff, executive director

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of the Malaysian Institute of Economic Research (MIER), says there are clear signs that the government is telling such firms that the days of coddling are over. “The old policies won’t work now under globalization. The place for protected industr ies has gone. The place for the Proton has gone. I believe in infant industry protection, but after 25 years is it still an infant? It still can’t grow up? Proton is one; iron and steel, they are just not competitive. If they

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ture.“As you move up the curve in development, the priorities of people change. The government is saying we have certain priorities; we have been elected for certain things—not necessarily a car,” he says. Higher on the list of priorities these days, says Cama, is good water and sanitation, and this is where the government will be spending economic pumppriming funds. It will no longer be spending big on infrastructure develop-

“THE NEW ADMINISTRATION IS TRYING TO GET BACK ON THE MAINSTREAM AND GIVE GREATER LEEWAY TO MARKET FORCES” “A relatively high budget deficit is due for trimming, and subsidies on fuel and other protectionist measures are on the way out.” —Zarir J. Cama, HSBC Malaysia were competitive, they would not need protection,” he says. Zarir J. Cama, head of HSBC Bank Malaysia, believes the government has recognized that there is no longer grassroots support for expensive backing of industries with an uncertain fu-

Yusil Mohamed Yusoff (left), Bursa Malaysia: “It’s quite natural for our companies to look beyond our borders” Mohamed Ariff (right), Malaysian Institute of Economic Research: “We are going to go for niche areas where it will take China some time to catch up”

ment because the job has been done, except in provinces that did not support the UMNO (United Malays National Organization) government. It is bringing forward some projects originally penciled in for 2006 to cushion the current downturn in the construction sector, Cama notes. Supporters of the hands-on approach from government say it has allowed Malaysian industry to develop expertise it could not have achieved in any other way. Proton may not be able to stand on its own feet in an open market, but it has spawned an automotive components industry that can. Construction is another industry that benefited from government injections of capital. Now, with less budgetary funds being pushed into infrastructure at home, Malaysia’s well-developed construction companies are looking offshore. They have developed good track records for medium- to high-cost work in the Middle East, India and Indonesia, notes Cama. “The new administration is trying to

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get back on the main stream and give a greater leeway to market forces,” says MIER’s Ariff. A relatively high budget deficit that came in at 4.5% last year is due for trimming, and subsidies on fuel and other protectionist measures are on the way out, albeit in stages, he says. “We keep on saying that it doesn’t make economic sense, that people must pay for the scarcity value of a product. The government understands that, but politically it is not easy to remove them too soon, so the government is trying to remove them slowly,” Ariff adds. Again, Malaysia has the flexibility that many other countries don’t possess. In reserve-rich Malaysia, big deficits are easily covered by mainly domestic borrowing in an environment of high liquidity. Yusil Mohamed Yusoff, CEO of Bursa Malaysia, formerly the Kuala Lumpur Stock Exchange, is confident that Malaysian companies can now compete in a far bigger marketplace.“It’s a logical step for Malaysian companies that have done well. Our population is only 23 million. If you have so much market share, you can’t expand much further, so it’s quite natural for our companies to look beyond our borders,” he says.

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Banks are moving to Indonesia and the Philippines, and securities house CIMB recently bought Singapore-based broker GK Goh. State oil company Petronas is active in as many as 35 countries. MIER’s Ariff says the new administration of Abdullah Badawi is determined to internationalize the Malaysian economy.“We see China as a challenge, not as a threat but an opportunity, but we’ve got to move away from the collision course with China so we’ve got to realign, change direction a little bit and make our economy more complementary to China. We are going to go for niche areas where it will take China some time to catch up,” he says. In current terms this means biotechnology and nanotechnology. Critics who say that this is just another example of government wishful thinking point to earlier support for information technology industries that have not achieved targets. Of the IT experiment, HSBC’s Cama says it is unfair to say it failed.The government-backed IT “city,” Cyberjaya, is impressive, he says, with a strong backbone underlying the infrastructure. “HSBC is there.We’ve got a magnificent office there. It’s a processing center for all

Malaysian Prime Minister Abdullah Badawi, center, on a tour of a craft complex after launching National Craft Day in Kuala Lumpur, Malaysia

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parts of the world, one of our seven or eight global sites, with approximately 2,000 people,” he says. HSBC would like to expand at Cyberjaya, but the country’s emerging problem—scarce human resources—is a barrier. There is general acknowledgement in the community that Malaysia’s early plus, its peoples’ facility in the English language, is eroding. Says Cama:“If you ask should you go in for nanotechnology and biotechnology, well, I guess countries have aspirations. These things are important for a countr y, to make these attempts. Malaysia might have a niche presence in biotech, so if I was sitting somewhere where I could take a decision on this, I would look at the particular strengths and concentrate on these and become a leader.” Ariff adds that Malaysia is pushing into the higher end of the spectrum in electronics, one of its main export industries. “We are going into services. We want to make ourselves as complementary to China as we can, so we want to re-invent the economy.We are going to move away from unskilled labor-intensive, low-value-added activities into skilled, higher technology, higher added value,” he says. What’s more, the government and bureaucracy are receptive to change and communication. Ariff says the bureaucracy is much more open: “The Prime Minister has put a lot of emphasis on this.The bureaucracy may not be moving as fast as the PM would like, but things are moving much faster here than they are in many neighboring countries,” he notes. There are still plenty of wrinkles yet to be ironed out. The New Economic Policy, introduced after race riots in 1969, continues to discriminate in favor of indigenous Malays, at the expense of Chinese and Indian citizens. Bursa Malaysia’s Yusoff defends the policy. “In the case of Malaysia—multiracial, multicultural—the government has to have a balance on which way to

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MALAYSIA

MALAYSIA’S PEG: “WE KNOW THE OPTIONS” ressure on China to untie its currency from its peg to the US dollar brought similar pressure on the other Asian country operating a currency peg, Malaysia. Keith Loveard talked to Zeti Akhtar Aziz, governor of Malaysia’s central bank, on this and other issues.

1980s and early 1990s it was trade flows. Now it is financial flows. These financial flows are highly volatile. If we compare ourselves to our neighbors who have flexible regimes, our currency and their currencies have actually been moving quite closely. We have not really deviated very much from the movement of currencies in this region.

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What is Malaysia’s policy on the peg to the US dollar given the pressure on China’s currency?

Photo: Shahrul Mizan Hashim

The other action Malaysia took in 1998 was to introduce capital controls. Would you ever repeat We have had this regime in place now for seven that action? years, and it has been functioning very well in terms of looking at how it has facilitated our trade and We have moved to in fact liberalize our exchange investment. Our trade has been very robust, and administration rules. We have removed almost all of investment flows have also been very significant, so the rules that were in place, and one of our most it has not in any way inhibited these kinds of flows recent liberalizations is to allow foreigners to raise and activities. All the factors that support the bonds in our domestic market. functioning are sound. We have a high level of reserves, our foreign indebtedness is low, our Is the progressive liberalization recognition of banking system is strong and sound, and so on, so we the growing maturity of the Malaysian economy? Dr. Zeti Akhtar Aziz, governor of are not under any specific pressure. The currency is We have always said, and have always honored as not misaligned; it is not under pressure. It is slightly Malaysia’s central bank well, that we will sequence our liberalization undervalued but not to any extent we are worried according to the capacity of our economy to absorb about. If there is a change in the environment, like it. In the meantime, like in the development of the financial sector, we have a China making some change in some currency regime, because China is such a master plan that was issued in 2001, and this charts the development and significant country in our region, it is very likely that everyone in our region provides the direction. The first phase up to 2004 was what we described as will look at their position. We are in a state of readiness; we know what options capacity building, institutional development and financial infrastructure we have. In between fixed regime and freely floating there is a wide range of building. Our banks now have a minimum size where they can take advantage options that are possible, and we know what the implications of each one of of economies of scale, they can invest in technology. Our banks have been able these are; we have the expertise here; we have done all the simulations under to retain their market share, and in some cases they have been able to different conditions. What will always remain the same is our over-riding enhance their market share. They are more competitive, more viable. objective: to have stability of our currency with our major trading partners. Doesn’t the fluctuation in the value of the dollar itself remove some of the value of Malaysia’s peg?

Is the increasing presence of Malaysian banks in regional business a sign of this increasing maturity?

Most of the trade is done in US dollars. It still facilitates trade and investment; it gives a degree of predictability in trade and investment activities. That is important to us because we are one of the most open countries in the world, and when we talk about globalization, we have been more integrated with the global economy than most other economies. Our trade volume is two times the size of our economy; it is 200% of GNP. Obviously if we had a widely fluctuation currency, it would be highly destabilizing for us.

They have to seek our approval, and we look at their capacity, and indeed several of our banks are venturing beyond our borders, to Indonesia, to the Philippines. These are all possibilities. They are now looking beyond the region to West Asia as well as to the Middle East.

Surely, given the strong underpinnings of the economy, there would be little chance of wild fluctuations in any case, reducing the justification for the continuing existence of the peg? Right now you have to look at what determines the exchange rate. In the

go. If you have a balanced system, you will forego certain benefits of the free market system, but you avoid some of the problems that could accompany a free market system where you had some segments of the population advancing at a much faster pace than the others,” he explains.

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Does liberalization mean that the remaining sectors closed to foreign investment will be opened? We have a national agenda and what is important is that we are very transparent. We indicate the areas we want to promote; now we are promoting the services sector, over and above the manufacturing sector, where you can have 100% ownership. But at the same time we want to nurture certain industries. Like any economy, we have what is described as a protection phase, but it is essentially very transparent.

“The free market system works well when you don’t have to worry about a multiracial system. We recognize the sensitivity this creates. Perhaps you see a greater level of government intervention, but on the whole it has served the country very well. The question is, Do you have to do this forever?” he asks.

He believes the government recognizes the job has been done and is opening up bit by bit. Political leaders, up to the Prime Minister himself, acknowledge that corruption is a problem. Yusoff spoke to Global Finance just as his exchange was under fire after a series of stock

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MALAYSIA AIMS FOR GLOBAL ROLE IN ISLAMIC BANKING arir J. Cama recalls that when he took up his post as CEO of HSBC Bank Malaysia in 2002, people told him they thought his new home could play a role in Islamic finance. “When I came here, I was constantly told that the aspiration was to become the regional hub for Islamic finance. My response was, Why do you want to be the regional hub? You should be the global hub for Islamic finance.”

first half of this year, sukuk issues stood close to $6 billion. Some of those issues were listed on the Malaysian exchange.

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Yusil Mohamed Yusoff, CEO of Bursa Malaysia, is upbeat on Islamic finance. At the moment, Islamic assets make up 10% to 15% of total issues on the Malaysian exchange. The domestic market is quickly adopting shariah finance systems, he says, adding that “there’s a lot of room to grow when you think that half of the population is Muslim.” Around half of the bonds issued on Malaysian markets are Islamic, recognizing that this is one of the most developed markets for bonds. Recently an arm of the World Bank issued bonds on the Malaysian exchange.

In three short years, partly through Cama’s enthusiasm and a concerted effort from both the government and the private sector, Islamic finance has grown from a bit-part to a major starring role in Malaysia’s banking sector. “We’ve moved down that curve very smartly, very strongly, in terms of the government absolutely believing that it can take this opportunity,” says Cama. “In Malaysia today a little over 11% of our total balance sheet is Islamic. When I came that figure was 0.2%. After two years our balance sheet is RM38 billion to RM40 billion.”

While growth in the bourse’s Islamic market has been strong, Yusoff warns that Malaysia’s niche play is under threat. Some Muslim investors say Malaysia’s shariah rules “vary” from the orthodox, but the bourse chief says the criteria are adequate for most investors, and Middle East issues are very welcome on Zarir J. Cama, HSBC Bank Malaysia: his market. “We want to pursue the growth of Islamic Cama believes there is more upside to come. He Promoting Islamic finance capital markets, [and] what would be even nicer for us knows Malaysia can’t hope to handle all the emerging would be to get some of those Muslim issues,” he business in the fast-growing sector, but there are says. More Middle Eastern visitors represent a strong positive for Malaysia. niche markets within the overall Islamic finance sector where Malaysia does have a unique opportunity. HSBC itself, he says, has played a dual role. First, it participates actively in the market, developing products for commercial gain. The other, equally critical part of his work has been “to participate with government and regulators to build the infrastructure, the laws, the regulatory structures, the legal system that surrounds it. This business cannot exist in a vacuum,” he explains.

Much of the legal and regulatory infrastructure praised by Cama has been the work of the governor of Bank Negara Malaysia, Zeti Akhtar Aziz. She says, “In many countries where Islamic finance exists, it manifests itself in banking mainly, but we have the whole infrastructure, including the financial markets, the money market, which allows flexibility in the management of funds, the bond market, the equities market.”

A benign view and will on the part of government has been an essential ingredient. Cama praises the approach of Malaysia’s leadership: “The regulators here, the government, the central bank—the governor is the champion—they are pragmatic people, they say they require building blocks, and they are asking people what they need.” On the public’s side, he says, there is no shortage of people who believe in Islamic finance.

“We have the legal infrastructure; we have all the legislation in place; we have the supervisory and regulatory framework in place; we have Islamic insurance growing significantly,” says Zeti. “In all these areas, and all our specialized institutions like our mortgage corporation that issues mortgage papers, securitized from the banking system, this all allows the financial services to function as a form of financial intermediation across the board,” she notes.

Taxi driver Sulaiman Hamid is among them. “I feel far happier that my housing mortgage is based on Islamic financial principles,” he says. “It actually costs me a little more than a traditional mortgage, but the sense of having done the correct thing is very important.” It’s not only Malaysia’s Muslims who are getting benefit from the fast-developing Islamic finance sector, with many other investors helping push it to second place in the world after the Middle East. Bonds are a fast-growing market. Global issuance of bonds, known as sukuk, reached $6.7 billion last year, up more than four times on the 2003 figure. In the

manipulations that saw banks pull their support for many market players, sending the market index plummeting. But such growing pains are the exceptions in what is generally an upbeat picture. Analysts agree that Malaysia has got its recipe right. Credit Suisse First Boston (CSFB) gave Malaysia a glowing report after a series of meetings with senior government officials and private sector operators at the end of May.

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All Malaysian banks now have growing Islamic finance arms, and some are joining with institutions overseas to establish Islamic operations that build on the Malaysian infrastructure. Zeti is one who believes there is much more Malaysia can do to establish itself in Islamic finance. “The comprehensive nature [of Malaysia’s Islamic services]—and because the volume is increasing and because the infrastructure is in place—increases the potential for Malaysia to be a hub for Islamic financial services,” she says.

The report said that inflationary pressures were “benign” and that there was room for higher growth, with the investment-to-GDP rate at 27% still relatively subdued. Portfolio flows had picked up, and while it was impossible to tell how much of these flows were speculative,“even if there is a wholesale reversal of these capital flows, Bank Negara Malaysia [the central bank] has adequate foreign exchange reserves to

counter the drop in the monetary base,” the CSFB report said. While growth is likely to be down this year, the fundamentals remain strong. Ariff ’s own research group put first-quarter growth this year at 5.9%, well down on full-year 2004 growth of 7.1% and 7.8% in the first quarter of 2004, but enviable in many other economies. Clearly,Asia’s baby is growing up. ■

SECTOR REPORT FINANCIAL SOFTWARE

BY DENISE BEDELL

Made-to-Measure Finance Solutions Buying a custom-built finance solution, or commissioning tailor-made add-ons to existing systems, are increasingly real alternatives to buying out of the box. etting a custom-built baby is not just the domain of HarleyDavidson aficionados. Nowadays it is also all the rage for finance technology. Satellite firms offering advanced functionality and customized solutions on top of existing large-scale systems have always been around. But as companies have focused more and more on increasing efficiency of all systems, improving integration of disparate systems and consequently pulling value out of all business processes, so has interest in these custom solutions grown. One of the biggest developments in the role of the finance function in recent years is an increasing focus on developing and managing new technology aimed at increasing process efficiency across the financial supply chain. With limited IT budgets, these executives are tasked with the need to show a convincing returnon-investment (ROI), often over a short timescale. But as the technological desires of large-cap companies have grown, so has the gap grown between what bigname system suppliers offer and what those companies are looking for. That is where the small but specialized solution provider comes in.The financial technology market has seen a huge surge in interest in the offerings of smaller firms that aim to make existing enterprise applications better—not necessarily by changing those systems but through add-

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SECTOR REPORT

ons and custom functionality to turn those enterprise apps into the solutions that finance executives dream of. Sanjay Srivastava, chief operating officer of specialist IT firm Aceva, says the development of external firms dedicated to providing custom add-ons to major systems is a natural progression.“This has occurred in most other industries, so it makes sense for it to happen in the financial technology market. The breadth of functionality that the big banks and system suppliers are trying to achieve is simply not possible.” Srivastava says that within the enterprise space most enterprise resource planning (ERP) software began by focusing on the physical supply chain.“The reality is that ERPs have done a good job on the physical supply chain, but when you turn around and look at the financial supply chain, there are large gaps between what users need and what ERPs provide,” he says. Consequently, companies can end up with multiple ERPs managing different functionality across different parts of the organization. This works for the physical

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Sue Sadler, Honeywell (left): “We can look up 150 different things on an invoice and fix it ourselves” Sanjay Srivastava, Aceva (right): “There are large gaps between what users need and what ERPs provide”

generally expensive procedure. Honeywell hosts most of the major ERP platforms across their various business units, says Sue Sadler, Honeywell’s director of cash management. “With many acquisitions under our belt we naturally had numerous systems across our organization,” she notes. The biggest problem, she explains, was that the information they needed to make good cus-

HAVING A CUSTOM PACKAGED SOLUTION CAN FILL THE GAPS LEFT BY THE BIG NAMES supply chain, but for the financial supply chain it does not stand up.Thus, having a custom or at least a highly customizable packaged solution can fill the gaps left by the big names. This is particularly relevant for largecap corporations that have active M&A programs.With many new purchases this generally means many new systems that must somehow come together. This can either happen by rolling out head-company systems to subsidiaries, or it can mean developing complicated in-house solutions to get the various systems to speak with each other. Either way it involves a long, highly complicated and

FINANCIAL SOFTWARE

tomer decisions resided in different databases that did not speak to each other. “We knew what was causing difficulties in our invoicing, but we could not fix them without a huge process involving many different system suppliers,” she says. Honeywell set out to find a solution and discovered that Aceva could provide true customization with all systems. “They could pull together all our systems—shipping, manufacturing, forecasting and so on—into one system and give us all the information in one screen,” Sadler says.“We are able to have a whole information trail as well,” she adds. “We can look up about 150 different things on

an invoice and fix it by ourselves before an invoice is generated.” According to Stephen Blythe, founder of Blytheco, which offers custom add-ons to Best Software’s accounting systems, the size of the organization dictates whether a custom solution is appropriate. Smaller companies tend to want a prepackaged solution, but the larger the corporate the more likely that they will want some form of customization. A mid-size company, for example, will likely want a package that out of the box handles 98% of the functionality that they are looking for. “But they want this to follow their workflow needs; they do not want to change the business to suit this piece of software,” he says. For a large-cap company the package must mold to the business, he says: “Clearly, after that there will be much customization that needs to be done to meet their business model.” Getting that type of customization from the big system suppliers is possible but is generally a colossal task. “Every time we wanted to do something groupwide, it was a huge undertaking, and no one system could talk to everything,” says Sadler. “This is really what drove us to look at Aceva.” By choosing an outside firm that could work across the various systems, it made for a relatively painless implementation, she explains. ■

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ANNUAL SURVEY BEST SUB-CUSTODIANS

THE WORLD’S BEST SUB-CUSTODIANS nvesting in overseas markets is becoming routine, thanks to the efforts of sub-custodians, who work closely with local clearinghouses and depositaries around the world to handle transactions and supply securities services. Meanwhile, emerging markets are making foreign portfolio investors feel more welcomed by upgrading trading infrastructures and eliminating regulatory barriers. “Brazil, for example, used to be a complicated market to get into,” says Roberto Gonzalez Barrera, head of securities services for Latin America at Citigroup. “But the country has done a great job in facilitating foreign investment,” he says. These changes have had a major impact on the trading of government bonds and derivatives in Brazil, Gonzalez Barrera says. Meanwhile, more and more local market participants are seeking to adopt international standards and to invest outside of their home market, he says. “Pension funds in Latin America are seeking to use custodians to improve transparency,” the Citig roup executive says. “They are exporting capital outside of the region,” he notes. Global investing has become a two-way street.

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In the US market, sub-custodians are discussing ways to immobilize a growing range of sophisticated instruments, such as asset-backed securities, by making them depository-eligible, says Kevin Smith, senior vice president, global custody operations at Bank of New York. Much remains to be done in some areas, such as proxy services, Smith says.The US is the largest single market for class actions, he says, and there is room for more automation in this important sector. Sub-custodians, who for m the bedrock of the global securities business, are often hidden to the end users of custody services. But they deliver the products and services that enable investors to manage the risks and reap the rewards of cross-border investing. Global Finance editors and reporters, with input from expert sources, selected the winners from the financial institutions that reliably provide the best custody services in local markets and regions to global custodians, broker-dealers and institutional investors. We chose winners in eight regions and in 35 countries. Our criteria included customer relations, quality of service, competitive pricing, smooth handling of exception items, technology platforms, post-settle-

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Global Finance selects the winners in a specialized area of finance that is critical to global investing.

ment operations, business-continuity plans and knowledge of local regulations and practices. HSBC, which calls itself “the world’s local bank,” won 15 awards, far more than any other bank, thanks to its strong showing throughout Asia and the Middle East. Citigroup was second, with five awards, including regional honors for Latin America. While BNP Paribas repeated as the best sub-custodian for Western Europe, it faces growing competition from Citigroup.The US bank in June 2005 opened a new custody and clearing center in Breda, the Netherlands, following its acquisition of ABN AMRO’s direct custody, secur ities clear ing and fund-services business in eight markets last October. Consolidation in the sub-custody business continues, as margins narrow and technology advances. The need for major investments in systems and people to remain competitive makes the provision of sub-custodial services an area that not every bank wants to pursue. Those with economies of scale and the specific expertise needed to provide quality service are still able to make a good living at it, however, and are enjoying fundamental growth in areas such as risk monitoring and correspondent brokerage, according to industry participants. ■

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REGIONAL WINNERS ASIA

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HSBC HSBC is the leading sub-custodian in Asia, where it has an extensive network and detailed knowledge of local markets. HSBC’s securities subcustody and clearing business in the region is operated under the Hongkong and Shanghai Banking brand. HSBC is the leading foreign bank in China, with the largest branch network and the only onshore B-share custody operations. The B-share markets for foreign currency trading of China-based companies are located in Shanghai and Shenzhen. HSBC’s expertise as an Asian sub-custodian is not limited to China and Hong Kong, where it has a solid grip on the top position, but extends throughout the region. Global Finance named the bank the Best Sub-Custodian in India, Indonesia, Malaysia, the Philippines, South Korea,Taiwan and Thailand. HSBC’s Internet platform provides standardized as well as customized reports and services for global custodians, brokers, dealers and institutional investors. HSBC offers sub-custody services for both equities and fixedincome instruments.The bank’s core securities-related services include receipt and delivery of securities, safekeeping, securities lending, dividend and income collection, proxy services and portfolio reporting.The bank tailors its fees to each customer, based on asset sizes and volumes in particular markets. It offers automated-settlement coverage programs in some markets, whereby it borrows securities to cover positions to avert failed settlements and avoid damage to its clients’ reputations. www.hsbc.com

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Westpac Banking From Australia and New Zealand to Tonga and Vanuatu, Westpac Banking is the leading sub-custodian in Australasia.The Sydney-based bank has 1,000 offices across the region. With approximately $150 billion in assets under management, it is the largest domestic custodian in Australia. The bank’s secur ities clearing, settlement and safekeeping services are rated highly by its clients. Westpac’s custody operations serve global custodians, clearinghouses, brokers, dealers and investment managers. The bank’s sub-custody services cover a wide range of investment securities, including equities, corporate debt, government debt and money market instruments. With a focus on client service, the bank informs all customers promptly of dividends and corporate actions, as well as regulatory changes relating to the Australian Stock Exchange, and other market developments. www.westpac.com.au

CARIBBEAN Bank of Bermuda (HSBC) Bank of Bermuda continues to operate under its own brand, but its securities services are being integrated with those of HSBC, which acquired the Bermuda-based bank in February 2004. Bank of Bermuda’s global fund services, with expertise in serving hedge funds and private equity funds, is now known as HSBC’s Alternative Fund Services, or AFS. With service centers in 14 offices around the world, including the Cayman Islands and the Isle of Man,AFS has about $180 bil-

lion of assets under administration. Bank of Bermuda provides a full range of custodial services and specializes in customized services, such as the exception processing of nonstandard transactions. HSBC is reorganizing its global securities services business into four product lines, including sub-custody and clearing, alternative fund services, corporate trust, and institutional fund services.The institutional fund services line will concentrate on serving traditional funds and will include global custody as well as fund administration and performance consulting. www.bankofbermuda.bm

CENTRAL AND EASTERN EUROPE RZB Raiffeisen International, the Central and Eastern European subsidiary of Vienna-based RZB, is the leading bank in the region in terms of geographic reach, with a presence in 16 countries.The initial public offering of Raiffeisen International in April 2005 was the biggest IPO in the history of the Vienna Stock Exchange.The issue totaled €1.11 billion, including over-allotments, and was 22 times oversubscribed. RZB was one of the first Western banks to do business in the CEE region and now has 23,000 employees and 920 offices serving 5 million customers in the area.The bank uses its own subsidiaries as its sub-custodians and specializes in the brokerage, settlement and safekeeping of CEE securities. Raiffeisen International is one of the top banks in seven countries of South East Europe. It is the largest bank in Serbia and Montenegro,

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Bosnia and Herzegovina, and Albania. Raiffeisen International reported a 68.5% increase in firstquarter 2005 earnings before taxes, compared to the same per iod a year earlier, and a return on equity before taxes of 24.7%. RZB offers online custody reporting and efficient notification of company actions, such as dividend announcements and stock splits. www.rzbgroup.com

LATIN AMERICA Citigroup Citigroup is the leading sub-custodian in Latin America, where it has more branches and covers more markets than any other bank. In Mexico, for example, its Banamex unit provides custody services to 88% of foreign investors in the country’s markets. From its Tampa,

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Florida-based regional operations center, Citigroup has electronic links to depositar ies and exchanges throughout Latin America. It exited the sub-custody business in Bolivia in 2003 and relies on third-party agents in Ecuador, but the bank is the leading provider of securities clearing and custody services for foreign investors in seven countries in the region and is active in this area in three others. Citigroup representatives sit on the boards of local clearing houses and serve on technical committees in most of these countries. Citigroup’s brokerage subsidiary in Chile has an 85% share of the foreign broker-dealer business. Citigroup also is the leading provider of custody services for foreign investors in Brazil. www.citigroup.com

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MIDDLE EAST HSBC HSBC provides securities clearing and custody services in much of the Middle East, with operations in Bahrain, Egypt, Jordan, Lebanon, Oman, the Palestinian Autonomous Area, Qatar, Saudi Arabia and the United Arab Emirates. It was recently granted a license to open a branch in Kuwait. HSBC confirmed in May 2005 that it was in negotiations to acquire a majority stake in Dar Es Salaam Investment Bank of Iraq. British Bank of the Middle East, now called HSBC Bank Middle East, was founded in London in 1889. It has long provided financial services throughout the Middle East region. HSBC began providing securities services to global custodians and foreign insti-

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tutional investors in these markets as soon as they were opened to non-resident investors. The bank’s custody platform provides reports and communications links to keep clients infor med about local market developments and financial infrastructure. HSBC also helps clients apply for foreign investment licenses, tax clearance and reclamation of taxes, where applicable. The bank’s Web-based delivery platform, HSBCnet, connects to other services offered by the group and is integrated into the Swift network for global financial communications. www.hsbc.com

SOUTHERN AFRICA Standard Bank Standard Bank is the leading provider of custody services in South Africa for equities, bonds and money-market instruments, with a 40% market share. It also operates a regional custody network for subSaharan Africa that is active in 12

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countries. The bank provides custody, trustee, securities lending and accounting-related services to institutional investors in these markets. Standard Bank offers a range of i nve s t m e n t s e r v i c e s o f f s h o r e through its office in Jersey. It acts as a depositary for internationally traded secur ities and can provide a nominee company to reg ister clients’ holdings. It offers online trading and portfolio-evaluation services, as well as dividend collection and processing of corporate actions. Standard Bank, through its London office, offers global custody services in an alliance with Bank of New York. www.standardbank.co.za

WESTERN EUROPE BNP Paribas Paris-based BNP Paribas is continuing to expand its sub-custody business in Europe. The bank processed 23 million securities transactions in 2004 and ended the year with €2.47 trillion in assets under management.

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It expanded into the Austrian custody market in July 2004, when its Frankfurt branch established a direct link to OeKB, the Austrian central securities depositary. BNP Paribas provides securities clearing, sub-custody and outsourcing services for broker-dealers and institutional investors in 11 countries in Europe. BNP Paribas Securities Services also offers global issuer services to corporations and financial institutions, including local paying-agent services and global corporate trust. Its Global Fund Services unit offers fund administration, transfer agency, performance measurement, fund compliance and trustee services and outsourcing for institutional investors. The bank also provides financing to support clients’ securities-related activities. BNP Paribas launched an automated corporate actions service recently, using the CAMA application developed by London-based Information Mosaic. www.bnpparibas.com

COUNTRY WINNERS ARGENTINA HSBC HSBC has taken its licks in Argentina, but the wounds are beginning to heal, and its 1997 acquisition of financial services group Roberts SA de Inversiones is starting to pay off. HSBC Argentina earned $156 million in 2004, up from $48 million a year earlier.The bank has links to the central securities depository, the Caja de Valores, and the central bank, as well as ArgenClear, and provides efficient clearing and settlement services. HSBC also has one of the largest insurance businesses in the country and offers a comprehensive range of

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financial products, including private pensions through a venture with New York Life. www.hsbc.com.ar

AUSTRIA Bank Austria Creditanstalt Bank Austria Creditanstalt, Austria’s largest bank, owns a Swift-based high-volume settlement system for Austrian securities. In addition to serving global custodians and international investors, the bank provides custody and fund-administration services to domestic companies and institutions. Its offshore unit in the Cayman Islands offers trust vehicles and custody services, as well as mutual funds. Part of Germany-

based HVB, Bank Austria Creditanstalt’s first-quarter 2005 earnings rose 49% from a year earlier to €207 million. www.ba-ca.com

BRAZIL Citigroup Citigroup’s Citibank Brazil unit is the largest sub-custodian in the country, with about $57 billion of assets under custody for both local and international investors. The bank has electronic links to the CBLC, the depository and clearinghouse for equities, and the CETIP, for clearing corporate bonds. The bank’s securities country manager sits on the boards of both institu-

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tions and is vice president of the board of the CIP, the payments clearing house. Citibank Brazil offers safekeeping of securities, settlement, corporate actions management, dividend and income collection, and portfolio-valuation services. www.citibank.com.br

CANADA RBC RBC Global Services, part of Royal Bank of Canada, is the country’s leading sub-custodian. It offers transaction processing, investment administration and cash management to corporate, government and institutional clients. Nine of the world’s top 10 global custodians are customers of RBC. The bank, with $1.25 trillion of assets under management, was the first to introduce automated secur ities lending in Canada. RBC also provides domestic and offshore fund services, perfor mance measurement and tools to analyze trades before they are executed. www.royalbank.com

CHILE Citigroup Citigroup’s brokerage subsidiary in Chile is a member of the two major stock exchanges in the country. Citibank Chile offers a full range of securities services, including portfolio advisory and management services. The bank has influenced major changes in securities regulation, including the implementation of a nominee account

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structure at the central securities depository and the allowance of securities lending. Citibank Chile also helped to eliminate the need for official accounting and legal representation for foreign portfolio investors and to simplify documentation requirements. www.citibank.cl

CHINA HSBC HSBC is the leading foreign bank with the largest branch network and the longest uninterrupted presence in China. Last year it purchased a 20% stake in Shanghaibased Bank of Communications, China’s fifth-largest bank, for an estimated $1.75 billion. HSBC is the only foreign bank with onshore Bshare custody operations for trading of China-based companies in convertible currencies. It has a market share of more than 50% in the Bshare custody business. HSBC also offers qualified foreign institutional investors onshore custodian services in China’s A-share market. A-shares represent the largest class of Chinese shares and are traded in yuan. www.hsbc.com.cn

CZECH REPUBLIC Ceskoslovenska Obchodni Banka (CSOB) Well-capitalized CSOB, which is majority owned by Belgium-based KBC, is the Czech Republic’s largest bank, with 190 branches. It also is the country’s leading subcustodian. Assets under custody arrangements rose to $6.56 billion

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at the end of 2004, up from $5.84 billion a year earlier.With offices in Prague and Bratislava, CSOB’s custody unit offers securities clearing and settlement, income collection, corporate actions management and market analysis. The bank also has an asset-management subsidiary and can draw on the services of KBC Securities. www.csob.cz

FRANCE BNP Paribas BNP Paribas Securities Services in Paris is the hub of a European network of securities clearing and settlement services and a full range of custody-related products. Services for French companies include shareholder registrar services, employee stock-ownership and options plans, advisory services and support for securitizations. The securities services subsidiary also provides investment-operations support to issuers, financial intermediaries and institutional investors. It is adept at handling failed transactions and provides financing and management of collateral. www.bnp.fr

GERMANY Deutsche Bank Deutsche Bank’s Trust and Securities Services unit, or TSS, handles $3 trillion of debt and equity securities. TSS provides safekeeping and clearing services for securities in 25 markets worldwide. In 2002 Deutsche Bank sold substantial parts of its global securities services

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business to State Street of the US. It retained its sub-custody network in Europe, Latin America and Asia, however, as well as its domestic securities services business. It augmented its German book of business in 2003 when it acquired €200 billion of custody assets from Dresdner Bank, which was a well-established provider of custody services in the country. www.db.com

GREECE National Bank of Greece National Bank of Greece is the oldest and largest Greek bank, with 600 branches and one-third of the country’s banking business. Its National Securities subsidiary is the leading brokerage house in Greece and offers a full range of investment products. The bank ranked first among primary dealers in government bonds in 2004 for the fourth year in a row. In May 2005 National Bank of Greece agreed to merge with National Investment, which manages stock portfolios and mutual funds. The bank’s Luxembourg-based investment companies offer umbrella funds with a range of sub-funds and access to international markets. www.nbg.gr

HONG KONG HSBC HSBC, through Hongkong and Shanghai Banking, controls more than half of the market for custody and clear ing services in Hong Kong. Its securities operations center provides centralized securities processing for the bank’s custody and clearing, asset management, trustee and brokerage businesses based in Hong Kong. HSBCnet, the bank’s Web-based delivery platform, provides support for settlement, registration, corporate actions, re-

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mittances and reconciliation of secur ities transactions. All of the bank’s centers are integrated into the Swift network. HSBC is a major participant in the international securities lending and borrowing market and has a trading desk for this activity in Hong Kong. www.hsbc.com.hk

INDIA HSBC HSBC was the first foreign bank to offer custodial services to international institutional investors in India and is the largest participant in this market.The bank’s sub-custody services are tailored to local conditions and regulatory requirements. For its portfolio-valuation service, HSBC obtains securities price feeds from the National Stock Exchange and the Stock Exchange, Mumbai. The bank uses software developed by Credit Rating Information Services of India for the valuation of debt instruments. HSBC provides a broad range of trustee and investor services, including compliance monitoring and market information. www.hsbc.com.in

INDONESIA HSBC HSBC has been serving global custodians, fund managers and brokerdealers in Indonesia since 1991. Hongkong and Shanghai Banking opened its first Indonesian office in Jakarta in 1884.The bank offers accounting and administrative support for equity and fixed-income funds. It also provides customized services through its corporate trust agency unit. HSBC has obtained approval from the central bank for sub-registry of gover nment bonds and Bank Indonesia certificates, or SBIs. Last year it launched the first Indonesian government bond index. HSBC Securities Indonesia is a

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member of the Jakarta and the Surabaya stock exchanges. www.hsbc.com.in

ISRAEL Bank Hapoalim Bank Hapoalim, Israel’s largest bank, is the country’s leading subcustodian, with a 30% market share overall and a 40% share with respect to the activity of foreign investors. Its brokerage subsidiary is the leading trader on the Tel Aviv Stock Exchange. The bank’s London-based Poalim Asset Management (UK), established in 2001, offers mutual funds, alternative investments and structured investment products to high-net-worth clients worldwide. Bank Hapoalim’s first-quarter 2005 earnings rose 80.5% from the same period a year earlier. The gain reflected the sale of its shares in New York-based private bank, Signature Bank, in March 2005. www.bankhapoalim.co.il

ITALY Banca Intesa Banca Intesa, Italy’s largest bank, with assets of €275 billion at the end of 2004, is the country’s leading provider of securities services. The bank offers custody, clearing and settlement services for foreign investors accessing the Italian securities markets. It asset-management subsidiary, which is being merged with that of Crédit Agricole, is one of the largest such operations in Italy. Banca Intesa has more than 3,000 branches in Italy and is on a buying spree in Central and Eastern Europe. In February 2005 it launched a tender for ABS Banka in Bosnia and Herzegovina. In March it acquired Delta Banka, Serbia’s second-largest bank. In April it gained control of KMB Bank in Russia. www.bancaintesa.it

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JAPAN Sumitomo Mitsui Banking Sumitomo Mitsui Banking, Japan’s third-largest bank, is the country’s leading provider of custody services.The bank recently launched a system to provide information on corporate actions through its website. It also has established a support desk for trading in Japanese government bonds, as well as an information and advice center for proxy voting. Sumitomo Mitsui Asset Management, founded in December 2002, has more than $84 billion of assets under management. The bank posted a $2.2 billion loss for the fiscal year ended March 31, 2005, as it accelerated the process of disposing of its bad debts. www.smbc.co.jp

MALAYSIA HSBC Bank Malaysia HSBC Bank Malaysia has had a presence in the country for more than 120 years. It is the largest custodian for foreign investors in the Malaysian market, where it has offered custody and clearing services for more than 30 years. The bank has 4,300 employees, an increase of 900 from a year ago. It operates 36 branches as well as a call center that serves the entire HSBC group. After Hong Kong, Malaysia is HSBC’s second-biggest business in Asia.The bank is eager to take advantage of financial liberalization in Malaysia, which will be fully open to foreign bank competition in 2008 in line with World Trade Organization rules. www.hsbc.com.my

MEXICO Banamex Banamex, owned by Citigroup since 2001, is the top provider of custody services for foreign in-

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vestors in the Mexican market, with a market share of approximately 88%.The bank is the largest in Mexico, with 1,400 branches. It offers a full range of financial services, including an online securities brokerage, known as AcciTrade. Banamex introduced an online negotiation platform for securities lending in February 2005. The system enables institutional investors and fund managers to concentrate their debt and equity securities-lending transactions and related services in a single site. www.banamex.com

NETHERLANDS BNP Paribas France-based BNP Paribas is the sub-custodian of choice by global custodians and foreign investors in the Dutch market. It is facing competition from Citigroup, which acquired ABN AMRO’s direct custody, secur ities clear ing and fund-services businesses in the Netherlands and other European and Asian markets in October 2004. BNP Paribas provides securities services and investment operations support to issuers, financial intermediar ies and institutional investors. The bank offers securities and derivatives clearing and outsourcing for broker-dealers. It also provides fund-administration services, shareholder services for corporations and securities lending. www.bnpparibas.nl

PERU Citigroup Citigroup’s Citibank Peru has captured 95% of the market for custody and clearing services for foreign institutional investors in Peru. Citibank Peru is an indirect participant in the Central Securities Depository. It has had a presence in the country for 85 years and began of-

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fering custody services in Peru in 1992. Citibank Peru offers banking, insurance and investment products and operates a securities brokerage subsidiary. The bank has about 460 employees and offers a wide range of securities services. www.citibank.com.pe

PHILIPPINES HSBC HSBC is the leading provider of custody and clearing services to foreign portfolio investors in the Philippines. The bank’s Manila office offers online trade settlement with the Philippine Central Depository, as well as safekeeping of securities, and proxy voting and nominee services. HSBC has had a presence in the Philippines for more than 120 years and began offering domestic custody and clearing services in 1955. It has provided similar services for foreign investors since 1985.The bank offers flexible and responsive customer service. www.hsbc.com.ph

POLAND Bank BPH Bank BPH is a leading provider of securities-settlement services in Poland, where the bank has a network of 560 branches. Part of Germany-based HVB Group, the bank is 71% owned by Bank Austr ia Creditanstalt. Bank BPH turned in a solid financial performance in 2004, more than doubling its net income. The bank was formed by the 2001 merger of BPH and PBK, two of the nine commercial banks spun off by the National Bank of Poland in 1989. The Bank BPH name was adopted in 2004. The bank’s shares are listed on the Warsaw Stock Exchange, and its global depositary receipts trade on the London Stock Exchange. www.bph.pl

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PORTUGAL Banco Espirito Santo Banco Espírito Santo, or BES, is one of the largest providers of subcustodian services in Portugal. Since November 2003 it has been a clearing member of the Euronext markets of Lisbon, Paris, Amsterdam and Brussels. Its brokerage unit is a trading member of these markets and offers clearing services in all of them to non-resident institutional clients. BES is a settlement agent for Euronext Lisbon and over-the-counter trades. It executes all corporate actions associated with securities safekeeping and assures the processing of all income collections regarding the assets under custody. BES also offers a proxy voting service. www.bes.pt

RUSSIA ING Bank ING Bank (Eurasia), par t of Netherlands-based ING Group, is the largest custodian in Russia, with about $37 billion of assets under custody. ING Bank began providing custody services in Russia in 1995 and acquired Credit Suisse First Boston’s local custody activities in 2002. ING’s custody operations include settlement, clearing and safekeeping of both domestic and international equity and fixed-income securities. The bank also provides clients with corporate-actions announcements and market information, income collections and repatriation, and proxy voting. ING acts as local sub-custodian for many depositary receipt programs. www.ing.ru

SINGAPORE United Overseas Bank One of Singapore’s leading banks,

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United Overseas Bank offers comprehensive custody services, including settlement, safekeeping and registration of securities. The bank has 68 branches in Singapore, as well as a growing international network, with offices in 17 countries. In 2004 it acquired a 97% interest in Bank of Asia, Thailand, with a network of 133 offices. It also purchased a 23% interest in Bank Buana Indonesia last year. UOB Custody Services collects dividends, interest and bonus-share entitlements and supplies comprehensive reports on securities transactions and accounts. www.uobgroup.com

SOUTH KOREA HSBC HSBC is the largest foreign custodian in South Korea, which it entered in 1992 when the country’s markets first opened to foreign investors. In July 2003 HSBC acquired a majority stake in Asset Management Technology Korea, which has $27 billion of funds under administration. HSBC handles about half of the market for custody and clearing services for foreign institutional investors in South Korea. So far, HSBC has refused to pay the asking price for major local banks that have come on the market, but it is eager to expand its operations in the country. www.kr.hsbc.com

SPAIN Santander Central Hispano Santander Central Hispano, Spain’s largest bank, is also the country’s leading sub-custodian. The bank operates in 40 countries and has a large presence in Latin America. The group’s securities and investment activities are conducted under a variety of names, including SCH Bolsa in Spain, Santander

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London in the UK and Santander Investment Securities in the US. Santander’s acquisition of UKbased Abbey, which was completed in November 2004, increased funds managed on behalf of customers by 70%, to more than $750 billion. The bank’s first-quarter 2005 income, which included Abbey for the fir st time, rose 38.5% to $1.47 billion. Not including Abbey, ear nings would have been up 20.6% from the same period a year earlier. www.bsch.es

SWEDEN Skandinaviska Enskilda Banken Skandinaviska Enskilda Banken, or SEB, provides global custody services for domestic institutions in Sweden, as well as sub-custody services for foreign institutions investing in Sweden and elsewhere in the Nordic region. SEB’s assetmanagement activities include mutual funds, portfolio management and private banking. The Stockholm-based bank has about $125 billion of assets under management. SEB has 675 offices in 20 countries, including Germany, the Baltic countries and Scandinavia. It owns SEB Trygg Liv, one of Sweden’s largest life insurers. www.seb.se

SWITZERLAND Credit Suisse Credit Suisse is the leading subcustodian in Switzerland, where it offers a full range of securities services and special expertise in Swiss franc-denominated equity and fixed-income securities.The bank’s Zurich office acts as a principal for securities lending and borrowing in the Swiss market. Credit Suisse Zurich is a securities broker and can offer financial products traded

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on various exchanges. It offers settlement services to members of Virt-x, a cross-border exchange for top European stocks, and to remote members of SWX Swiss Exchange through an automated system that is available to both Swift and non-Swift users. www.credit-suisse.com

TAIWAN HSBC HSBC has been offering custody and clearing services to foreign investor s in Taiwan since 1991, longer than any other bank. It is the leading custodian in Taiwan, with a market share of about 30% among institutional investors. In 2001 HSBC acquired a majority interest in China Securities Investment Trust, Taiwan’s leading asset manager. HSBC also operates an insurance brokerage business in Taiwan. HSBC Taiwan posted pretax earnings of $110 million in 2004, an increase of 30% from a year earlier. www.hsbc.com.tw

THAILAND HSBC HSBC is one of the largest subcustodians in Thailand, with a 25% market share among foreign investors in the country. The bank first began offering sub-custodian services in Thailand through a subsidiary in 1987. HSBC also operates a stock brokerage subsidiary, HSBC Securities (Thailand), and offers a full range of investment services, including mutual fund sales.The bank’s securities-processing system was developed as part of its Web-based delivery platform, HSBCnet. The system provides efficient processing of transactions and keeps clients informed of market developments. www.hsbc.co.th

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TURKEY GarantiBank GarantiBank, the leading sub-custodian in Turkey, has been providing custody and clearing services to foreign investors operating in the country’s capital markets since 1989. It is the only locally owned provider of custody services with a significant market share. In July 2004 Italy-based Banca Intesa broke off negotiations for the purchase of a controlling interest in GarantiBank from the Dogus Group. GarantiBank is part of a network of European secur ities services providers through a cooperation agreement with France-based BNP Paribas Securities. www.garanti.com.tr

UNITED ARAB EMIRATES HSBC HSBC’s operations in the United Arab Emirates include HSBC Bank Middle East, HSBC Insurance Brokers, HSBC Finance and HSBC Bank International, which provides offshore banking services. In July 2000, when the UAE market opened to foreign investors, HSBC was the first bank to provide custody and clearing services. HSBC Bank Middle East offers a wide range of investment services, including debt capital market services, asset management, corporate finance, private equity and securities broking. The bank opened a new office in downtown Dubai last September and operates customer-service centers at major shopping malls. www.uae.hsbc.com

UNITED KINGDOM HSBC Britain’s largest bank, HSBC is also its leading sub-custodian.With more than $1.5 trillion of assets under custody, it offers first-rate global cus-

BEST SUB-CUSTODIANS

tody and domestic UK sub-custody services through its London-based Global Investor Services division. The GIS unit also has operations in Edinburgh and Dublin. HSBC Global Fund Services, another unit of the bank, offers fund administration and investment services to hedge funds, funds of funds, emerging market funds and private equity funds.The bank’s asset-management and international fund administration businesses were boosted by the acquisition last year of Bank of Bermuda. The HSBCnet platform provides HSBC clients with realtime reporting of cash and securities positions. The bank recently began offering electronic proxy services to institutional investors for their holdings in 43 markets worldwide via ADP Investor Communications Services. www.hsbc.co.uk

UNITED STATES Bank of New York With nearly $10 trillion of assets under custody and administration, Bank of New York provides securities services in more than 100 markets worldwide. Its Brussels operations center is its custody hub in Europe. In the US, Bank of New York recently announced that it was reappointed as master custodian and securities-lending agent for the Alaska Permanent Fund following a competitive review. The fund is a public trust created for the citizens of Alaska and has a market value of $30 billion.The bank entered into a marketing alliance in May 2005 with KPM Technologies to help nonprofit organizations automate the administration of their endowment funds. Last year, it purchased a 51% stake in Netik, a data-warehouse technology service used by fund managers. www.bankofny.com

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CORPORATE FINANCING FOCUS

Euro’s Heightened Political Risk Does Not Detract From Success Of Single Currency, Analysts Say

T

he clear “no” votes in the Netherlands and France on the EU Constitution led some market participants to remark that the euro has become a currency without a country. Italian labor minister Roberto Maroni even suggested that Italy should consider dropping the euro as its currency. Maroni is a member of the Northern League regionalist party, which fights for a separate state for northern Italy. He said the lira, Italy’s former currency, should be temporarily reintroduced because the euro has led to economic problems, including a loss of competitiveness and high unemployment. Italy’s finance minister, Domenico Siniscalco, rebutted this argument, saying that returning to the lira made no sense because it would raise the cost of

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financing Italy’s debt. The euro weakened sharply in response to the twin “no” votes, but analysts say the initial reaction appears to have been overdone.The European monetary union, or EMU, is not about to fall apart and the euro will still achieve full reserve-currency status, although it may take somewhat longer than had been expected, currency market analysts say. “The votes against the constitution have raised the perceived political risk in Europe and put the spotlight on some of the relative-growth issues and the difficult economic backdrop,” says Robert Lynch, head of Group of 10 foreign exchange strategy, the Americas, at HSBC

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Bank in New York. “The euro itself has been a success, not only as a big, active market, but also as a medium of exchange,” Lynch says. “The euro is backed up by a liquid money market and is useful to investors,” he says. While the immediate market impact of the Dutch and French “no” votes was a great deal more significant than had been expected, the outcome of the voting will not change the viability of EMU as a project, according to Lynch. “Over time, the euro will still take on a greater role as a reserve currency,” he says. World central banks have increased their holdings of euros from 12.7% of international reserves at the end of 1999 to 18.4% at the

end of 2003, according to the International Monetary Fund, and HSBC estimates that the percentage of reserves in euros rose to 20.4% in 2004. Despite the euro’s recent slip, it likely will continue to perform well against the dollar over the longer term, Lynch says. “At the end of the day, the US still runs considerable twin [current account and budget] deficits, and there still will be issues associated with funding the deficits,” he adds. The dollar’s gains so far this year, reflecting capital flows into the US, do not mean that foreign appetite for US assets will remain strong forever, Lynch says. Growth in the US economy likely will slow later this year, at about the same time that market participants become

convinced that the Federal Reserve is almost done raising interest rates, and this could set the stage for a renewed decline in the dollar, according to Lynch. Other analysts also say they have not abandoned their longer-term bearish views on the dollar. “The more the dollar strengthens, the more US external imbalances are compounded, and the greater the likelihood of a disorderly adjustment later,” says David Gilmore, economist and partner at Essex, Connecticutbased Foreign Exchange Analytics.

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will increase spending to try to stimulate job growth. “Alternatively, they could take an even darker path of importing prosperity with deliberate efforts to weaken the euro a lot more,” he says. “Or they could do nothing and wait to be voted from office.” However, in order for there to be a major sustainable downward trend in the euro and rise in the dollar, Gilmore says, there will need to be a reduction in the US budget deficit. “On the surface, US economic fundamentals appear strong, and they appear very strong next to

CENTRAL BANK HOLDINGS OF EUROS (Percentage of International Reserves) 25

20

20.4

15

15.4

15.7

2000

2001

18.0

18.4

2002

2003

12.7 10

5

0 1999

2004 Estimated

Source: HSBC, International Monetary Fund

“This is not the end of the euro, as some have claimed,” Gilmore says. “Central banks are not going to reduce euro reserves; they are likely to continue to add to them despite the political crisis.” The real danger ahead, according to Gilmore, is that the French and German governments, in a desperate attempt to remain in office,

Europe and Japan,” Gilmore says. “But probe under the armor, and the knight is soft and vulnerable,” he says.

Political Impact Stephen F. Auth, executive vice president and chief investment officer at Pittsburgh, Pennsylvaniabased Federated Investors, one of the largest investment

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managers in the US, says the principal impact of the referenda in France and the Netherlands is political, not economic. The proposed constitution would provide a political framework for Europe, he says. In contrast, the current monetary union, which broke down most trade barriers between member nations and provided a common currency, remains intact, he says. “Almost everyone Stephen F. Auth, agrees that economic chief investment officer, reforms are necessary if Federated Investors Europe is to be competitive,” Auth says. “But when it comes to about the euro,” Auth says. such reforms, the proposed “Euro strength has been all constitution has no about the Chinese and real teeth.” Japanese attempts to keep What’s more, their currencies pegged to restructuring is already the dollar.” occurring in Europe, and During the latest cycle the pace is accelerating, of dollar weakness, Japan Auth says. “The drivers and China have not been haven’t been government purchasing their own entities,” he says. “They currencies with the have been and will be dollars they hold, he says. individual businesses with Instead, they have an instinct for survival.” purchased euros, driving Under the monetary up the value of the euro, agreement, companies in according to Auth. countries with high tax The situation could rates, such as France and change some time in the Germany, must compete next 12 months, he says, but with the likes of Ireland, not until the US stops where the tax rate is only pressuring China to revalue. 10%, Auth says. In response, “While revaluation probably the companies of “Old would benefit China in its Europe” are improving their fight against inflation, that own internal productivity, nation’s leaders do not want often by moving facilities to to be seen as caving in to markets with lower labor US demands,” Auth says. costs within the EU, he The drop in the euro was adds. going to occur anyway, whether or not the constitution was voted up Not About the Euro or down, says Carl B. Weinberg, chief economist “Where currency itself is at Valhalla, New Yorkconcerned, it’s never been 2 0 0 5

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based High Frequency Economics. “Interest-rate spreads rule, and spreads have moved in favor of the dollar,”Weinberg says. “Traders are being paid to short the dollar.” The EMU will be around for a very long time, he says, because it would be extremely costly for a country to drop out. If Italy were to drop the euro, it would cost it several hundred basis points more to borrow, he says.

Hotel California “The EMU is like the Hotel California,”Weinberg says. “People go in but they don’t come out.To leave now would require the economic equivalent of

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war,” he says. “Meanwhile, the big developed economies of Western Europe are experiencing a structural disarray caused by what’s going on with EMU,” he says. “They are having to adjust to a lower standard of living.” Flat to lower labor costs will persist in developed Europe,Weinberg says. “Fiscal policy in Germany cannot make wages grow strongly again.There can be a rise in government spending, but not in workers’ incomes,” he says. The rejection of the EU constitution by voters in France and the Netherlands represents a setback for further EU integration and expansion and coordinated

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countries probably will continue on the policy path that has yielded relatively successful results,” Mercier says. “In fact, lesser policy coordination at the EU level may paradoxically give them more leeway to reform, particularly if attempts to harmonize tax or labor law stall,” he says.

structural reform, says JeanFrancois Mercier, European economist at Citigroup in London. But the abandonment of the constitution would not mean the unraveling of the EU or EMU, which would continue to operate under current treaties, he says. “A key implication of weaker EU institutions and stalled integration could be a persistent and widening performance gap across the EU,” Mercier says. The EU countries that implemented the most farreaching reforms, notably the UK, Sweden, Finland and Ireland, have enjoyed stronger economic performance in the past decade, he says. “As a result, these

EMU Timetable The timetable for EMU membership of the 10 new member countries that already have joined the EU is unlikely to be affected, since it will depend on economic and fiscal performance in these countries rather than EU institutional issues, according to Mercier.

CURRENCY FORECASTS 0.7

1.0

Euro (Euro/US$)

0.9

UK (Pound/US$) 0.6

0.8 0.5 0.7

Source: Bank of New York

Forecast

Source: Bank of New York 0.6

Forecast

0.4 J

J

A

S

O

N

D

J

F

M A

2004

M J

J

A

S

O

N

D J

F

2005

M

A

M

J

A

2006

S

O

N

D

J

F

M A

2004

140

M J

J

A

S

O

N

D

J

F M

A

M

A

M

2006

2005

1.6

Japan (Yen/US$)

120

J

Switzerland (Franc/US$)

1.4

100

1.2

80

1.0 Source: Bank of New York

Forecast

60

0.8 J

J

A

S 2004

O

N

D

J

F

M A

M J

J

2005

A

S

O

N

D J

F

M 2006

A

M

Forecast

Source: Deutsche Bank J

J

A

S 2004

O

N

D

J

F

M A

M J

J

2005

A

S

O

N

D

J

F M 2006

CORPORATE FINANCING NEWS FOREIGN EXCHANGE

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“Similarly, the outlook for 2007 EU entry of Bulgaria and Romania remains relatively safe,” he says. “The case for countries yet to negotiate their entry, including Turkey, Croatia and Serbia, is more tricky, and existing EU members will adopt a tougher negotiating stance in the wake of popular concerns about enlargement,” Mercier says. But EU entry for these countries will not happen for some time, leaving them ample time to meet the entry criteria, he says.

US Advantage Meanwhile, the US economy appears to be growing at a healthy pace, and US short-term rates are rising, giving the dollar an opportunity to take advantage of the euro’s current misfortunes, analysts say. However, the US employment report for May surprised financial markets, with job growth of 78,000, the lowest in nearly two years, coming in even below the most bearish forecasts. The dollar declined initially on the weaker-thanexpected report, but analysts say the temporary setback was not enough to force the dollar bulls to capitulate their positions. “Indeed, the report is far more positive than the headline number suggests,” says Michael Woolfolk, senior currency strategist at Bank of New York. For one thing, the unemployment rate fell to 5.1% in May, the lowest since September 2001. And the household survey of employment conditions 6 4

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showed continued strength, remaining out of synch with the payroll data. “Continued pessimism in business confidence appears to be weighing on job growth in the service sector, contrasting with the rebound in consumer confidence and strong spending activity,”Woolfolk says. With unemployment continuing to fall as incomes rise, the US economy remains well supported by consumer spending, he says. In this light, weakness in the manufacturing sector and shaky business confidence will not get in the way of the Federal Reserve, which will keep raising interest rates at least a quarter point at each of its scheduled meetings this year, until the federal funds target rate reaches at least 4%, Woolfolk says. In Congressional testimony in June, Fed chairman Alan Greenspan said it was difficult to know where the neutral federal funds rate is, but that the Federal Open Market Committee will probably know it when it sees it. Greenspan’s comments suggested that it is still too early for the Fed to begin thinking about a pause in its policy of gradually raising rates,Woolfolk says. Meanwhile, the tone of comments from officials at the European Central Bank has changed since earlier this year, analysts say. ECB officials seem less likely to raise rates in the face of continued weaker-thanexpected economic growth across Europe, they say. —Gordon Platt

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CURRENCY FORECASTS 1.6

Canada (C$/US$) 1.4

1.2

1.0

Forecast

Source: Bank of New York J

J

A

S

O

N

D

J

F

M A

2004 14

M J

J

A

S

O

N

D

J

F

2005

M

A

M

A

M

A

M

A

M

A

M

A

M

A

M

2006

Mexico (Peso/US$)

12

10

Forecast

Source: Bank of New York 8 J

J

A

S

O

N

D

J

F

M A

2004 4.0

M J

J

A

S

O

N

D

J

F

2005

M 2006

Brazil (Real/US$)

3.5 3.0 2.5

Forecast

Source: Deutsche Bank 2.0 J

J

A

S

O

N

D

J

F

M A

2004 1.6

M J

J

A

S

O

N

D

J

F

2005

M 2006

Australia (A$/US$)

1.4

1.2

Forecast

Source: Bank of New York 1.0 J

J

A

S

O

N

D

J

F

M A

2004 9.0

M J

J

A

S

O

N

D

J

F

2005

M 2006

China (Yuan/US$)

8.8 8.6 8.4 8.2 8.0

Forecast

Source: Deutsche Bank J

J

A

S

O

N

D

J

F

M A

2004

M J

J

A

S

O

N

D

J

F

2005

M 2006

1600

South Korea (Won/US$)

1400 1200 1000 800

Forecast

Source: Deutsche Bank J

J

A

S

O

N

D

J

F

M A

2004

M J

J

A

S

O

N

D

J

F

2005

M 2006

1.8

Turkey (Million Lira/US$) 1.6

1.4

1.2

Forecast

Source: Deutsche Bank J

J

A

S 2004

O

N

D

J

F

M A

M J

J

2005

A

S

O

N

D

J

F

M 2006

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US HIGH-YIELD NEW-ISSUANCE VOLUME

Repatriation Could Trigger Corporate Debt Pay-Down

20 18 2004

16

The repatriated funds also will reduce future corporate borrowing requirements, he says. According to a study conducted by JPMorgan, of the $354 billion after taxes that could be repatriated, $162 billion, or nearly half of the total, could be directed toward debt reduction. The greatest beneficiaries of the new legislation will be multinational corporations in the pharmaceutical, technology, consumer-products and diversified industrial sectors, according to JPMorgan. These companies have the largest cumulative unrepatriated profits before 2003, and most enjoy substantial positive cash flows and cash balances, the study says. Healthcare and pharmaceutical companies have the potential to reduce their debt by between $44 billion and $88 billion, depending on what proportion of the repatriated funds are used for this purpose, it says. In January 2005, the US

2005

14

($ billion)

Cash-rich US companies may use billions of dollars of repatriated foreign earnings to pay down their debt, potentially driving spreads tighter as the supply of corporate bonds diminishes, analysts say. Under the American Jobs Creation Act of 2004, signed into law by President George Bush last October, companies are allowed on a one-time basis to repatriate profits generated at overseas subsidiaries at a much lower than usual tax rate. Companies can repatriate all of the cumulative overseas profits earned through 2002 at an effective tax rate of 5.25% instead of the normal corporate tax rate of about 35%. Economists estimate that these overseas profits could total $500 billion or more. “We believe that companies will use a substantial amount of repatriated profits to retire debt and address under-funded pension plans,” says Edward B. Marrinan, head investment-grade strategist at JPMorgan Chase in New York.

12 10 8 6 4 2 0 Jan

Feb

Mar

Apr

May

Lazard Alliance One International KB Home TECO Energy Seneca Gaming Ventas Realty Ventas Realty Greenbrier Companies Borden US Finance/Borden 2 James River Coal Yellow Roadway Source: KDP Investment Advisors

Offer Date Coupon % 5/4/05 5/10/05 5/25/05 5/23/05 5/18/05 5/26/05 5/26/05 5/5/05 5/16/05 5/24/05 5/19/05

7.125 11.000 6.250 6.750 7.250 7.125 6.750 8.375 9.375

Issue Type Senior Notes Senior Notes Senior Notes Senior Notes Senior Notes Senior Notes Senior Notes Senior Notes Floating-Rate Notes Senior Notes Floating-Rate Notes

Jul Aug

Sep

Oct

Nov

Dec

Source: KDP Investment Advisors

Internal Revenue Service, in conjunction with the Treasury Department, issued a notice that explicitly states that companies may use their repatriated earnings to pay down their debt. In a second set of repatriation guidelines issued on May 10, 2005, the Treasury and IRS provided details on what dividends qualify for a deduction under the new legislation. A third notice will be released soon that will discuss the impact of repatriation on a corporation’s computation of its tax liability. Once the guidelines are clear, analysts expect companies to begin the

TOP US HIGH-YIELD ISSUES IN MAY 2005 Issuer

Jun

Maturity Date Private/Public Amount ($mil) 5/15/15 5/15/12 6/15/15 5/1/15 5/1/12 6/1/15 6/1/10 5/15/15 7/15/10 6/1/12 5/15/08

144A 144A Public 144A 144A 144A 144A 144A 144A Public 144A

550 315 300 200 193 175 175 175 150 150 150

process of repatriating funds for a variety of purposes, including debt repayment. “We have already seen some of this type of activity,” says Margo L. Cook, head of institutional fixed-income management at BNY Asset Management, Bank of New York’s investment management division.“This implies that spreads will be well-behaved and that there may even be some tightening,” she adds. Nonetheless, there still will be a healthy supply of new corporate bonds coming into the market, Cook says. Repatriated funds can also be used for hiring and training workers, capital investment, research and development, certain mergers and acquisitions within the US, advertising and marketing, and other activities. Before repatriating the earnings, a company must have a domestic reinvestment plan for these funds that is approved by the company’s CEO or president and is subsequently approved by its board. —Gordon Platt

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Coal Miner, Bank Open China’s IPO Floodgates

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corruption at the bank. China Minsheng Banking, the country’s first privately owned bank, also is expected to come to market this year, seeking to raise about $800 million. China’s banks have reduced their huge backlogs of non-performing loans and are seeking to increase their competitiveness ahead of the entry of foreign banks into the business of dealing with Chinese citizens in yuan late next year. Meanwhile, China Cosco Holdings, the country’s largest container shipping company, raised $1.22 billion in an IPO on June 30 that fell 10% in its first day of trading.The company is planning to expand its shipping capacity and build new ports. Shenhua Energy’s listing on the Hong Kong Stock Exchange on June 15 was the exchange’s fifth-largest IPO ever, and the largest since China Life Insurance raised $3.4 billion in December 2003. The coal company’s offering was managed by

shares in the IPO to maintain its stake and has an option to double its holding within four years after August 2008, pending regulatory approval. BoCom, with 2,600 branches in 137 cities across China, has more than 50 million customers. China Construction Bank, the country’s thirdlargest lender, plans to raise $5 billion this year. Meanwhile, Bank of America announced in June that it would purchase $2.5 billion of shares in the state-owned bank and another $500 million in the IPO to secure a 9% stake in the bank. The purchase is the largest-ever foreign investment in a Chinese bank. China Construction Bank’s chairman, Zhang Enzhao, stepped down in late March and was subsequently detained by police amid allegations of

Deutsche Bank, Merrill Lynch and China International Capital, China’s largest investment bank, which is headed by Levin Zhu, son of former Premier Zhu Rongji. Shenhua Energy sold $150 million of its shares to Anglo American, the world’s second-largest mining group. Another $500 million was sold to four Hong Kong-based conglomerates and investment groups. Originally, Shenhua Energy had planned simultaneous listings in both Shanghai and Hong Kong, but the mainland listing was canceled in light of poor market conditions. Shenhua Energy earned $1.07 billion in 2004 and expects earnings to rise by 57% to $1.7 billion this year. The company’s proved and probable coal reserves of 5.9 billion metric tons are second worldwide, behind those of Peabody Energy of the US. Shenhua owns its own transportation system, including a number of railways and ports. —Gordon Platt

REGIONAL ADR INDEXES 180 Latin America

Europe

Asia

160

140

120

100

May 13, 2005

May 27, 2005 May 31, 2005

Apr 29, 2005

Apr 1, 2005

Apr 15, 2005

Mar 4, 2005

Mar 18, 2005

Feb 4, 2005

Feb 18, 2005

Jan 7, 2005

Jan 21, 2005

Dec 10, 2004

Dec 24, 2004

Nov 12, 2004

Nov 26, 2004

Oct 29, 2004

Oct 1, 2004

Oct 15, 2004

Sep 3, 2004

Sep 17, 2004

Aug 6, 2004

Aug 20, 2004

Jul 9, 2004

Source: Bank of New York

Jul 23, 2004

Jun 11, 2004

80 Jun 25, 2004

China’s biggest coal producer and the country’s fifth-largest lender made initial public offerings in June that set the stage for a flood of Chinese IPOs this year, mainly by state-owned companies. China Shenhua Energy, which operates 21 mines mainly in western and northern China, raised $2.95 billion in the biggest IPO in the world so far in 2005. However, fears that coal prices could be peaking kept investors from lining up outside banks in Hong Kong to buy Shenhua Energy’s shares. The company sold less stock than it was hoping to, and the shares fell 2.7% in their first day of trading, after having been priced near the bottom of the expected range. Demand was brisk, however, for the $1.88 billion offering of a 13% stake in Bank of Communications, the first of at least three share sales planned by China’s banks outside the mainland this year.The offering, arranged by HSBC and Goldman Sachs, was priced at the high end of its expected range.The shares rose 13% in their first day of trading on June 23. London-based HSBC, Europe’s largest bank by market value, paid $1.75 billion last year for a 19.9% stake in Shanghai-based Bank of Communications, also known as BoCom. HSBC also purchased

May 31, 2004

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Deal Helps Bank Austria Take Clear Lead in CEE Erich Hampel, CEO of Bank Austria Creditanstalt, writing in the bank’s 2004 annual report, said, “In Central and Eastern Europe, our goal is to become market leader.” Hampel and Bank Austria are on the verge of realizing that goal, perhaps sooner than he expected. As a result of Europe’s largest-ever cross-border bank merger, announced on June 12, 2005, between Italy’s biggest bank, UniCredit, and Bank Austria’s German parent HVB, Hampel will find himself at the helm of an expanded Bank Austria, which will be the CEE’s leading bank by far. UniCredit, formerly UniCredito Italiano, agreed to buy HVB, Germany’s second-largest bank following Deutsche Bank, for $18.7 billion in an allstock transaction. The CEE division of the combined bank will be run by Hampel and will control about 20% of the fastgrowing region’s profitable banking market. UniCredit plans to offer five new shares for each share in HVB. It also will buy HVB’s Bank Austria and BPH in Poland. Some 22.5% of Bank Austria’s shares are publicly held. “This deal makes a lot of sense to us,” Morgan Stanley analysts said in a note to clients. “Cash cow in Italy, growth in Central and Eastern Europe, and

restructuring in Germany and Austria. We like it,” they said. Bank Austria already had a presence in 14 CEE countries, including major market shares in Poland, Croatia and Bulgaria.The acquisition of Bank Austria would double UniCredit’s assets in Eastern Europe and create a lender twice the size of its nearest competitor, Austria-based Erste Bank. UniCredit began expanding in the CEE region after the Bank of Italy blocked its attempt in 1999 to acquire Banca Commerciale Italiana. UniCredit owns the leading private bank in Poland, Bank Pekao; the largest bank in Croatia, Zagrebacka Banka; the biggest bank in Bulgaria, Bulbank; the fifth-largest bank in the Slovak Republic, UniBanka; one of the Czech Republic’s main commercial banks, Zivnostenska Banka; and UniCredit Romania. In Turkey, UniCredit has a partnership with Koc, a Turkish industrial group, with whom it recently purchased Yapi Kredi, Turkey’s fourthbiggest bank. Bank Austria has a significant presence in Southeast Europe, a region that enjoyed the strongest economic growth in Europe in the past four years, with real growth of 23% in the period, according to a study by the bank. The region,

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comprised of the Balkan countries to the east of Italy, achieved the strongest growth of income in the world, with an increase of about 50% since 2000, it says. The banking market in Southeast Europe had exceptionally strong loan growth of 29% annually in the past four years, according to Bank Austria. While CEE growth is appealing, Alessandro Profumo, UniCredit’s chief executive, says, “Germany is strategic.” Profumo is betting that he can revive HVB’s sluggish domestic operations and that he won’t find any skeletons in

the German bank’s realestate loan portfolio. HVB has had to write down billions of dollars in defaulted real-estate loans in eastern Germany in the past three years. Meanwhile, Austriabased RZB is continuing to build up its network in the CEE, where it has a presence in 15 countries. The International Finance Corporation on June 21, 2005, agreed to provide $200 million to RZB’s 70%-owned subsidiary Raiffeisen International in the form of loans to finance small and mediumsize enterprises in Belarus, Russia and Serbia. —Gordon Platt

AMERICAS M&A: TOP DEAL ADVISERS Rank Value % Mkt # of ($million) Rank Share Deals

Adviser Goldman Sachs Morgan Stanley UBS Merrill Lynch Lehman Brothers Industry Totals*

165,328 150,685 117,543 97,016 96,869 448,308*

1 2 3 4 5 -

36.9 33.6 26.2 21.6 21.6

72 73 48 40 49 3,573

EUROPE M&A: TOP DEAL ADVISERS Rank Value % Mkt # of ($million) Rank Share Deals

Adviser Morgan Stanley JPMorgan Goldman Sachs Rothschild Deutsche Bank Industry Totals*

99,835 82,774 78,423 72,577 64,377 303,577*

1 2 3 4 5 -

32.9 27.3 25.8 23.9 21.2

56 69 42 73 39 3,613

ASIA M&A: TOP DEAL ADVISERS Adviser Nomura Morgan Stanley Mitsubishi Tokyo Financial Merrill Lynch JPMorgan Industry Totals* January 1, 2005 – June 1, 2005

Rank Value % Mkt # of ($million) Rank Share Deals 70,421 52,724 50,187 49,637 45,531 153,083*

1 2 3 4 5 -

46.0 34.4 32.8 32.4 29.7

62 28 38 17 6 3,246

Source: Thomson Financial Securities Data

* Figures may not add up, as more than one bank typically obtains credit for any one transaction.

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TOP MERGERS AND ACQUISITIONS (MAY 1, 2005–JUNE 1, 2005) AMERICAS Date Announced

Target Name (Target Advisers)

5/9/05

Cinergy (Merrill Lynch)

US

Duke Energy (UBS Investment Bank) (Lazard Freres)

5/24/05

PacifiCorp (UBS Investment Bank) (Morgan Stanley)

US

5/2/05

Neiman Marcus Group (Goldman Sachs) (JPMorgan)

5/4/05

Country

Acquirer Name (Acquirer Advisers)

Ranked Value ($billion)

Country

Description

US

Definitively agreed to merge with electric and gas utility, in a stock-swap transaction.

14.14

MidAmerican Energy US Holdings (Houlihan Lokey Howard & Zukin)

Unit of Berkshire Hathaway definitively agreed to acquire electric utility from Scottish Power; includes assumption of $4.3 billion in liabilities.

9.40

US

Investor group (Credit Suisse First Boston)

US

Texas Pacific Group and Warburg Pincus agreed to acquire owner and operator of specialty retail stores, for cash and stock, in a going-private deal.

5.19

Renal Care Group (Morgan Stanley) (BankAmerica)

US

Fresenius Medical Care (Deutsche Bank)

Germany

Definitively agreed to acquire provider of dialysis services for cash; includes $500 million in liabilities.

5/4/05

SpectraSite (Lehman Brothers) (Evercore Partners)

US

American Tower (Citigroup) (Credit Suisse First Boston)

US

Definitively agreed to merge with owner and operator of wireless communications towers, in a stock swap.

3.91

5/18/05

Hylsamex (Morgan Stanley)

Mexico

Grupo Techint (Citigroup)

Argentina

Planned to launch a tender offer to acquire manufacturer of steel products from Grupo Industrial Alfa and shareholders.

2.41

5/5/05

Storage USA (Morgan Stanley)

US

Investor group (UBS Investment Bank)

US

Prudential Financial and Extra Space Storage agreed to acquire REIT from unit of General Electric Capital.

2.30

5/19/05

Maytag (Lazard)

US

Investor group (Citigroup) (Goldman Sachs) (JPMorgan) (Deutsche Bank)

US

Definitively agreed to acquire manufacturer of household appliances, in a leveraged buyout.

5/26/05

Wind Telecomunicazioni (Morgan Stanley) (Merrill Lynch)

Italy

Weather Investments (Deutsche Bank) (Banca IMI) (ABN-AMRO) (Rothschild) (UBS Investment Bank)

Egypt

Sawaris family company agreed to acquire 62.75% of telecommunications company, in a leveraged buyout.

5/8/05

Edison

Italy

Investor group (BNP Paribas) (JPMorgan) (Merrill Lynch) (Morgan Stanley) (Rothschild) (Mediobanca)

France

Group including Electricité de France planned to increase its interest to 63.56% by acquiring a 50% interest in electric utility.

9.51

5/17/05

Viterra (Morgan Stanley) (Deutsche Bank) (Ernst & Young)

Germany

Deutsche Annington Immobilien (Rothschild) (Citigroup)

Germany

Agreed to acquire real-estate agency from E.On, in a leveraged buyout; includes assumption of $3.8 billion in liabilities.

8.97

5/2/05

Banca Antonveneta (Morgan Stanley) (Goldman Sachs)

Italy

Banca Popolare di Lodi Scarl Italy (Dresdner Kleinwort Wasserstein) (Lazard)

Launched a competing bid to acquire the remaining 70.9% interest it did not already own.

6.41

5/5/05

Basell (Credit Suisse First Boston) (Lazard)

Netherlands Investor group (Merrill Lynch)

Agreed to acquire maker of polypropylene from joint-venture partners BASF and Royal Dutch/Shell Group.

5.70

5/13/05

Edison

Italy

Group including Electricité de France planned to acquire the remaining 36.44% stake it did not already own.

4.72

5/11/05

Koninklijke P&O Nedlloyd (Citigroup) (Rothschild) (JPMorgan)

Netherlands AP Moller Maersk (Goldman Sachs)

Denmark

Planned to launch a tender offer for provider of transportation arrangement services.

3.14

5/30/05

Banca Intesa’s non-performing loans

Italy

Italy

Merrill Lynch and Fortress Investment agreed to acquire non-performing loan portfolio.

2.62

5/16/05

Yellow Brick Road (UBS Investment Bank) (Goldman Sachs JBWere) (Lazard)

Netherlands European Directories (Macquarie Bank)

Australia

Investor group agreed to acquire directory publisher in leveraged buyout.

2.34

5/2/05

Namco (Nomura Securities)

Japan

Bandai (Daiwa Securities SMBC) (KPMG FAS)

Japan

Planned to acquire the remaining 93.65% it did not already own in maker of games and toys.

1.40

5/9/05

Ping An Insurance (Goldman Sachs) (Morgan Stanley)

China

HSBC Insurance Holdings

UK

Agreed to raise its stake to 19.9% by acquiring 9.9% from Goldman Sachs and unit of Morgan Stanley.

1.04

4.00

1.97

EUROPE

US

Investor group France (JPMorgan) (BNP Paribas) (Merrill Lynch) (Morgan Stanley) (Rothschild) (Mediobanca)

Investor group (Merrill Lynch)

12.60

ASIA

Source: Thomson Financial Securities Data

6 8

J U LY/A U G U S T

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